History suggests that primary commodity prices have always approximated equity yields. Unfortunately, it does not tell us why, nor if commodity prices should continue to behave in this manner in the future, and theory is equally dumb. This has also been true for gold since it has been freely traded, and in my last article, I demonstrated that this relationship between commodities and yields does more to account for the fluctuations in the price of gold than do more popular explanations such as inflation, real interest rates, the value of the dollar, fear and manipulation. In this article I will show how the history of silver backs up this hypothesis.

Gold has only been priced by the market for four decades. In that time, it has demonstrated a few peculiar characteristics that set it somewhat apart from many other commodities. Having covered these in greater detail elsewhere, I

For anyone who has been ultra-bullish on gold (GLD), the last month has undoubtedly come as a great shock. Some have claimed that it was a shell game all along. Although I have written about the behavior of gold in greater detail on previous occasions, I think a more comprehensive review of why the conventional views on gold prices are flawed (no matter what ideological or economic school you subscribe to) and where we should look for more reliable indicators would be timely. Much of this applies to silver (SLV), as well, which has also been battered since 2011 (down 50% now).

First, let's look at what are some of the most common myths about what drives gold behavior. I should say that I do not regard "myth" as necessarily a pejorative term, but I believe that a comparison of the relatively short history of gold trading (only four

Last year, I wrote about how medium-term movements (roughly five months to five years) in the long-term bond market seemed to be determined by two types of cyclicality. The bond rally on Friday has inspired me to revisit those elements to see what they might have to say about the bond market over the next two years. My sense is that we will almost definitely see significantly higher rates in 2014, but it is not clear if the rise in rates has already begun or will begin later in 2013.

That being the case, my general assessment is that although there is a possibility that we could see a bond (IEF) rally this year, the danger of being caught in the cyclical snapback is so severe that I cannot imagine taking anything but limited, tactical positions in bonds. Based on analysis elsewhere, I continue to believe that equities (DIA)

Judging from commentary on TV and around the web, there is increasing concern about the divergence in stocks (DIA) and Treasury yields (IEF) that has transpired this year. On Friday, the 10-year yield went as low as 1.68%, and this is considered a sign that the stock market has failed to take notice of a deterioration in underlying conditions. The unemployment numbers did not seem to help the bull case very much, and gold saw a nice little pop.

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(Source: Stockcharts.com)

The relationships that I use to guide my projections about long-term stock behavior suggest that overall conditions strongly resemble those we can associate with a bull market akin to the 1980s and 1990s (or possibly the mid-1970s). In my last article, I hope I did something to put a dent into the notion that falling commodities are necessarily bearish for equities. Sometimes it can

As I write this, the Dow (DIA) is crushing 14600 with one fist and threatening 14700 with the other. A number of commentators have noted recently that there is something rather strange about this charge upwards: its unusual composition, its typically American nonchalance with respect to woes abroad, and its failure to bring commodities along for the ride. The stock market just doesn't seem to "get it."

Depending on what technical techniques you might use, there may be good reason to expect a pullback of some kind in the near future, but in this article, I would like to argue that, based on an analysis of the historical relationships of bonds, equities, and commodities for the last few centuries, this is not an especially atypical bull, and it is more likely that stocks will be higher this time next year than lower. Any dips that come are likely to

Note: In this series, I am attempting to describe the fundamental relationships between and within the yield and price complexes.

Keynes wrote that the old gold standard functioned according to an unwritten set of principles, which he called "the rules of the game." The "rules" primarily referred to gold's role in international trade and finance, but in this article, I am going to refer to them as the broader relationship that gold had with prices and equity and bond yields.

In my previous article, I showed that there appears to have been a revolution in the way that gold relates to these factors. Understanding the nature of that revolution can help investors and citizens understand some of the paradoxes of the modern market.

First, let's review some of what we have learned so far. Or what we think we've learned, at any rate.

1. Real commodity prices have

Note: In this series, I am attempting to describe the fundamental relationship between yields and inflation.

Commodity prices have been highly correlated with equity yields for the last 140 years (inversely correlated with P/E ratios), and there is every indication that they were correlated with the rate of profit during the 140 years prior to that.

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("GYCPI" is the Grilli-Yang Commodity Price Index. Sources: For a comprehensive list of sources used in this article, please refer to my previous article.)

Under the dollar standard, all goods prices, including commodities, have been relatively suppressed. That is, when you take into account the decay of the value of the dollar, you will find that goods prices of nearly all varieties have been in a state of decline since Bretton Woods. Even taking into account the incredible commodity bull market of the last decade, this is still

(Note: In this "Inflation and Yields" series, I am outlining the fundamental relationships between and within yield and price complexes. In Part I of this article, we noted that deflated commodity and producer prices have been highly correlated with equity yields since 1871, in much the same way that producer prices were correlated with bond yields under the gold standard, a phenomenon Keynes called Gibson's Paradox. What is the connection? Part II looked at Britain. Part III looked at commodities in America. Parts IV and V examine the revolution in consumer inflation and stocks.)

The first thing we do, let's kill all the lawyers.

--Dick the Butcher

The Dollar's Service Charge: From Gibson to Gibson, Fisher, and Baumol

Perhaps the most frequently offered explanation for the inflation of services (including legal services) is an appeal to "Baumol's disease." Simply put, it is a wage and

(Note: In this "Inflation and Yields" series, I am outlining the fundamental relationships between and within yield and price complexes. In Part I of this article, we noted that deflated commodity and producer prices have been highly correlated with equity yields since 1871, in much the same way that producer prices were correlated with bond yields under the gold standard, a phenomenon Keynes called Gibson's Paradox. What is the connection? Part II looked at Britain. Part III looked at commodities in America.

Part IV examines the revolution in inflation, and V will look at how this revolution has impacted services, technology, and stocks.)

The Revolution in Prices, 1914-1959

Experience has finally caught up with Fisher's Theory!

[P]erhaps the Gibson phenomenon is no longer with us now that the markets have learned their Fisher.

--Milton Friedman and Anna Schwartz (1976)

Under the gold standard, nominal CPI prices

(Note: In this "Inflation and Yields" series, I am outlining the fundamental relationships between and within yield and price complexes. In Part I of this article, we noted that deflated commodity and producer prices have been highly correlated with equity yields since 1871, in much the same way that producer prices were correlated with bond yields under the gold standard, a phenomenon Keynes called Gibson's Paradox. What is the connection? Part II looked at Britain. Part III looks at commodities in America. Parts IV and V will break down consumer inflation and stocks.)

Gibson's Paradox in America, 1800-2010

In reality, high profits tend much more to raise the price of work than high wages.... In raising the price of commodities the rise of wages operates in the same manner as simple interest does in the accumulation of debt. The rise of profit operates like compound interest. Our

(Note: In this "Inflation and Yields" series, I am outlining the fundamental relationships between and within yield and price complexes. In Part I of this article, we noted that deflated commodity and producer prices have been highly correlated with equity yields since 1871, in much the same way that producer prices were correlated with bond yields under the gold standard, a phenomenon Keynes called Gibson's Paradox. Is there a connection? Part II looks at Britain. Parts III-V look at America.)

Gibson's Paradox in Britain, 1730-1913

The proportion which the usual market rate of interest ought to bear to the ordinary rate of clear profit, necessarily varies as profit rises or falls. Double interest is in Great Britain reckoned what the merchants call a good, moderate, reasonable profit…

--Adam Smith

There are a few general statements I can make about the period from 1730-1913 in Britain, the period of

Note: In this "Inflation and Yields" series, I am outlining the fundamental relationships between and within yield and price complexes. This article focuses chiefly on the price complex, but it is built in no small part on a previous article on the yield complex.

Since 1871, the "real price" of primary commodities (that is, commodities deflated by CPI) has been strongly correlated with equity yields.

(click to enlarge) (Source: Please see text for information on data.)

This bears such a striking resemblance to Gibson's Paradox--Keynes's name for the observation that, from 1730-1913, the nominal general price level was highly correlated with bond yields--that it is hard to believe that these are two discrete phenomena. That Gibson's Paradox was even stronger with respect to the wholesale price index (WPI), i.e., producer prices (PPI), lends credence to that belief.

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The question is how to reconcile these

In this series, I am attempting to describe the fundamental relationship between yields and inflation.

In the previous articles in this series, I said I would attempt to show that the real price of primary commodities (e.g., grains, metals, oil), but especially industrial commodities, were highly correlated with equity yields, and that this was likely the source of Gibson's Paradox.

Reliable equity data for the U.S. goes back to at least the 1870s, and is easily accessible from Robert Shiller's website. And although one always wants more data, there is a fair amount of historical commodity data from such sites as the St Louis Fed, the World Bank, the Global Price and Income History Group (GPIH), the International Institute of Social History (IISH), MeasuringWorth, the BLS, Long-Term Returns and other sites.

Demonstrating the relationship between commodity prices and equity yields

Note: In this "Inflation and Yields" series, I am attempting to outline the profound relationship between and within the yield and price complexes.

Since the end of Bretton Woods in 1971, virtually all real commodity prices have been positively correlated with equity yields. This is especially true of industrial commodities and precious metals. The US natural gas market is one of the few exceptions to this rule, and this appears to be a rather recent development.

Is this general correlation accidental?

Since the early 1970s, when the dollar standard came into its full glory, we have only had one clearly defined peak in equity yields (early 1980s) and one bottom (late 1990s). In my opinion, circumstantial evidence indicates that the correlation is not accidental, but I have struggled with the problem of causality.

This correlation smacks both of Gibson's Paradox (the observation made famous by Keynes that interest rates used

Note: In this series, I am outlining the fundamental relationship between prices and yields. Additional research over the last month has both delayed further installments and compelled me to address the Barsky-Summers thesis somewhat earlier in the series than I had originally intended. In this article, I hope to begin to clear a way to a general construction of the price complex, especially with respect to industrial commodities, its relationship with equity yields, and show how traders and investors can use this to their advantage.

Since the 1980s, you have not been able to walk out the front door without the postman, the cop walking the beat, or the next-door neighbor saying something about how real gold prices are an inverse function of real interest rates.

I kid. But, it is received wisdom that real interest rates are the driving force behind gold prices. This theory was developed by

In this series, I am attempting to demonstrate and describe the profound and unprecedented way in which the relationship between yields and inflation has changed over the past 140 years, from the time of Gibson's Paradox to the post-Bretton Woods order.

In the first article, I asserted that the relationship expressed in the simple equation

EY - DY - 10y + 1y = 0

did a remarkable job of expressing the movements of the S&P earnings yield (EY), the S&P dividend yield (DY), the ten-year Treasury yield (10y), and the one-year Treasury yield (1y).

It also did a fine job of modeling the relationship used as the basis of the so-called "Fed model" (EY-10y).

Unfortunately, as I previously recounted, the yield curve (10y-1y), highlights two fundamental and related problems with the equation.

First, the equation is useful for modeling trends in the particular yields, but not levels

In the beginning, commodity prices and yields were one.

Or at least as far back as 1730 and up until the 1910s, consumer and producer prices were highly correlated with equity and bond yields. That is to say, it was not the rate of inflation that was correlated with yields but the absolute level of prices that moved with yields.

When one considers the tremendous technological, ideological, demographic, scientific, and geopolitical changes that occurred over those centuries in contrast with the stability of this relationship, this suggests that we are confronted with something like a natural law of markets and economics. And, yet laws were made to be broken, it seems.

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(Note: All data in this article comes from Robert Shiller, except corporate bond data in the chart above, which is from the St Louis Fed).

Nowadays of course, nobody cares what the absolute

The most remarkable thing about the last fifty years of market history is not the booms and busts that have dominated the period, but the surprising degree to which macroeconomic forces have become correlated with one another.

The majority of those correlations appear to be grouped around the behavior of the earnings yield. In previous articles, I have written about how real commodity prices, as well as government deficits and spending levels, have been strongly correlated with the S&P 500 earnings yield, especially since the implosion of Bretton Woods.

For example, in the chart below, I took all commodity price data provided by the World Bank and calculated each one's correlation with the non-adjusted earnings yield of the S&P. Unfortunately, I couldn't find a more economic way of presenting the data; the extreme left is energy (coal, natural gas, crude oil), the extreme right metals (gold, silver, platinum, copper, tin,

With the approach of the "fiscal cliff" in the US, it might be useful to consider what effect significant deficit reduction might have on the Treasury market. Conventional wisdom appears to be all over the map.

Cardiff Garcia at FT Alphaville, quoting a SocGen report, suggests that a reduction in the supply of Treasuries would "be undoubtedly bullish", while an extension of current fiscal policies "could put upward pressure on long-term interest rates".

In January of this year, Lord Skidelsky, in a piece rejecting the commonsensical notion that "debt matters", wrote that "there is no connection between the size of national debt and the price that a government must pay to finance it".

And, in July, The Economist said, "There have been crises before, but not even the Great Depression pushed bond yields down this far or this widely. The records being set in the markets are

In previous articles, I have written about how, in the absence of a way to ascertain reversals in the secular disposition of treasuries, we can use a couple of intermediate-term tricks to help us along the way. And, I have surmised that, to a certain extent, we can leverage these techniques in such a way as to give us an idea as to when the bond bull has died. In this essay, I would like to talk about a third such trick that is a kind of hybrid of the previous two, and why this continues to make me bearish about bonds for the rest of the year and, somewhat more tentatively, for the next two years.

First, I have noted how there appears to be a strange five-year cyclicality to 10-year treasury rates. Since the demise of Bretton Woods, rates have tended to form a deep trough in years