Many are talking about the run-up in commodities in the past few years as a bubble. Others maintain increased economic activity will continue an up-trend in commodity prices for a long time into the future. I think it is useful to get some historical perspective. I have chosen to look at the CRB Raw Industrials Index, which is plotted for the past 60 years in the graph below (click to enlarge images).
We see that, after a brief Korean war spike, there were about 20 years of fairly stable commodity prices. Then, following a Viet Nam war spike, the oil crisis and high inflation of the late 70’s pushed the index into a new, more volatile higher range for about 25 years. In the past two years the index has pushed higher out of the range. Is this leading the way to a new higher range which will be stable for an extended number of years? Or is this a spike like that around 1951? Or will the index continue to climb for many years and not repeat the two “plateau” patterns of the past 60 years?
I would argue that the 1951 spike, associated with the Korean war, is not an appropriate comparison for the current situation. That was a short-lived, massive military effort, dwarfing current military action. The current commodity rise is associated with a different stimulus, rapidly increasing world-wide demand, and will not be short-lived unless there is a world-wide depression.
Thus, the question can have two answers, assuming the world economy has normal progress going forward. (By normal progress, I mean cycles of expansion and recession, but no serious depression.) Either supply and demand will come into a new equilibrium within the next 2-10 years as in the two previous plateau areas, or the index will continue higher for a period of time longer than 10 years. If the emerging markets can continue to grow with only limited setbacks, there may be a long wait for the next plateau arrival.
It is also very informative to look at commodities on an inflation adjusted basis. That is done in the following graph.
It is seen that this index has systematically fallen over 60 years with ten of the eleven cyclic minima falling on or near a downward sloping straight line support level. Only the 12/75 minimum, which occurred in the transition between the two plateaus in the first graph, is above the support trend line. In other words, the index during the 70’s to early 80’s displays a “bubble” behavior in inflation adjusted terms. In the last two years we have entered the same region as experienced in the last commodity “bubble”. This “bubble” remained in force for about 8 years and include one clear cyclic minimum (12/75) during that time.
If we try to project future performance of the index from past behavior, we could wait another 6 years (or even longer) to get a return from a “bubble”. It is possible that the index may never fall back below resistance 1 and that could become the new support. This index is plotted in US$. If there is sufficient devaluation of the dollar going forward, this new support could be established.
If the index penetrates resistance level 2, we may have to start considering that this time is different. One reason for ever higher resistance being violated would be ever increasing scarcity of industrial raw materials in the face of increasing demand.
Finally, when might we expect the next cyclic minimum in this index based on history? The following table lists the minima and intervals between minima for the past 60 years.
The average interval has been 62 months with +/- 19 mos. standard deviation. One standard deviation contains about 65% of outcomes, so we have a 65% probability that the next cyclic minimum will occur from 43 to 81 months after the last one in 11/01. That would indicate dates between 6/05 and 8/08. Unless we accept the little dip (X in the graph) at about 7/05 as a cyclic minimum, we will be outside this window at the end of this month.
If we look at two standard deviations, we will have a 95% probability. This window is between 11/03 and 3/10, indicated by the two down pointing arrows. If the X at 7/05 is accepted as a cyclic minimum, the end of the 95% probability window moves to 10/13. This indicates that, based on history, there is a 95% probability that the next cyclic minimum will occur between now and March, 2010 (or, possibly, October, 2013).
If the next cyclic minmum occurs at or near resistance 1 (or lower), we may still be following the historical pattern. If the minimum occurs much higher, the extension of past behavior patterns will be in question.