Since reaching a 25-year high of 365.45 on May 11th, the Reuters Commodity Index (CRB index) has been showing signs of fatigue, after a relentless four-year climb. The CRB index doubled from four years ago, led by commodity superstars, such as crude oil, copper, gold, platinum, silver, coffee and sugar. However, since topping out three months ago, the CRB index has slumped about 9%, whipping up speculation that the “Commodity Super Cycle” is fizzling out.
The Federal Reserve is betting that a slowdown in the US economy can keep the “Commodity Super Cycle” under wraps. If commodity prices are confined into a sideways trading range for an extended period of time, the year-over-year comparison of inflation readings would start to look good. The US economy slowed to a 2.5% annual growth rate in Q’2, after sizzling at 5.6% in Q’1. Also, Labor Dept apparatchniks have reported US producer prices rose a scant 0.1% in July.
Putting his fragile reputation on the line, Fed chief Ben Bernanke hinted at a rate pause on July 19th, despite elevated commodity prices. “The recent rise in inflation is of concern, and possible increases in the prices of oil as well as other raw materials remain a risk to the inflation outlook. On the other hand, a slowing economy should reduce inflation pressures,” he told lawmakers on Capitol Hill.
The Fed has reached the limits of its tightening campaign at 5.25%, fearful of tilting the US housing market into deflation. The number of unsold US homes on the market in July jumped to 3.86 million homes, or 7.3 months' supply at the current sales pace, the most since 1993. The median price of an existing US home was only 0.9% higher in July from a year ago to $230,000. Americans are expected to draw $257 billion of wealth out of their homes this year, according to Freddie Mac.
In the US, bond traders are betting that the “Commodity Super Cycle” has topped out for 2006, signaling a peak in inflation, and in turn, the end of the bear market for US 10-year Treasury Notes. Since peaking at 5.25% on June 28th, the US 10-year Treasury yield has declined by 40 basis points to 4.85%, with monthly US employment gains dropping by a third in Q2 from the previous quarter
Since the Reuters CRB index topped out at the 365-level on May 11th, the US T-Note-to-CRB ratio bottomed out at the 0.290-level, and rebounded to as high as the 0.322-level. With the US T-Note-to-CRB ratio penetrating its downward sloping trend-line, US bond bulls are expressing supreme confidence that the US fed funds rate and 10-year yields have both peaked at 5.25%, and that the good-old days for the “Commodity Super Cycle” are fading into history.
Crude oil was the big mover behind the Reuter’s CRB index, (energy is 33% of its weighting) and recently slumped from the $77 per barrel range to as low as $69.60 /bl last week. Crude oil has commanded an Iranian “war premium” of $10 to $17 per barrel this year. On August 20th, Tehran said it won’t suspend uranium enrichment, turning down the main UN demand to prevent it from building atomic bombs.
Iranian leaders have concluded that the only stumbling block to acquiring nuclear weapons and “wiping Israel off the map” is a pre-emptive US or Israeli aerial attack on its nuclear installations. If military action is chosen, Iran has vowed to shut down the Strait of Hormuz, jeopardizing 17 million barrels per day, thereby restricting shipping across the globe, and tightening the supply of commodities. However, if the US balks at military action, commodities could weaken in the short term, boosting bond prices and lowering yields.
Although a US-listed ETF for the Reuter’s CRB has not yet been created, Barclay’s Bank has created an Exchange Traded Note [ETN], representing the Dow Jones AIG Commodity Index (NYSEARCA:DJP-OLD) and an ETN for the Goldman Sachs Commodity Index (NYSEARCA:GSP). Deutsche Bank launched an ETF, ticker symbol DBC. Traders can utilize the Ishare for the Lehman 20-year US Treasury bond index (NYSEARCA:TLT) for betting on the direction of US long-term interest rates. PowerShares DB Commdty Idx (NYSEARCA:DBC) covers the commodity market.
Reuters Commodity CRB Index 10-yr chart: