Commodities Are on Fire, And That's Good News

by: Calafia Beach Pundit

This index of spot industrial commodity prices is up over 50% from March '09, and it is only 2% below its all-time high of July '08. I think this is highly significant, for a number of reasons.

Global growth: where there is this much commodity "smoke," there is almost surely some economic growth fire. Commodity prices don't move up strongly in the absence of demand. That almost all commodity prices are rising (and rising against virtually all currencies) is a good indication that the global economy is growing, and exceeding the expectations of the world's commodity producers.

Inflation: The world's central banks are about as accommodative as they have ever been. They are all fighting deflation, and they are all bent on ensuring that monetary policy presents no obstacle to economic growth. Short-term interest rates in many parts of the globe are at or near zero. That gold and commodity prices are rising sharply is an excellent sign that money is in abundant supply. An oversupply of money tends to increase the demand for tangible assets, since they are ultimately a hedge against the loss of value of fiat currency. Thus, rising tangible asset prices are an excellent indicator of potentially inflationary monetary policy. At the very least, strong commodity prices virtually rule out the risk of deflation.

Risky assets: Risky asset prices (e.g., equities, corporate bonds, emerging market debt) are arguably priced to the expectation that growth will be meager at best, and many are priced to the expectation that deflation is a significant risk. The action in the commodity markets says those expectations are way too timid, and that therefore risky asset prices are generally quite attractive. If instead of meager growth and deflation we in fact have generally strong global growth and at least some inflation, then nominal corporate cash flows are going to be much stronger than is currently being discounted. Growth plus inflation is a fantastic recipe for owners of high-yield bonds, for example, since those ingredients combine to deliver low default rates.