Historical CRB Charts and the Commodity Bubble

by: Tim Iacono

One of the most bothersome aspects of all the "commodity bubble" talk that has been going on for years now, talk that has intensified since the U.S. government began looking to assign blame for skyrocketing prices of food and energy on someone or something (anything) other than themselves, is the notion that soaring commodity prices are somehow unprecedented.

Nowhere is this theme more apparent than in recent testimony before Congress by the likes of airline investor Michael Masters (see Fun with the Michael Masters' report and More fun with the Michael Masters' report) where the following chart was presented as "proof" that nefarious "index speculators" (i.e., pension funds, endowment funds, hedge funds, et al.) are responsible for pushing prices higher.

As noted previously, this chart is deceptive on at least two levels - the choice of the index and the linear scale.

The Goldman Sachs Commodities Index [GSCI] and its component weights are determined based on a five year moving average of world production values and, as such, this has the effect of making this the most volatile of all commodity indexes because more weight is automatically allocated to commodities that are rising and less to those that are falling. This has resulted in an energy weighting of almost 80 percent today.

By the way, can anyone explain why the GSCI "spot" index rose 16 percent in 2006 as shown above but the GSCI futures index fell by about the same amount after that nasty energy sell-off late in the year? I just noticed that.

Having just come across detailed data for another popular commodity index - the Reuters-Jefferies CRB Index - it's worth noting again that the 1970s move in commodity prices compared to the one in recent years can appear much different depending upon the index.

The CRB index more than tripled during the 1970s versus a smaller overall increase in recent years even with the near-vertical gain of the last nine months.

The most deceiving part of any long-term chart, however, is the use of a linear scale versus a log scale. For anything more than 15 years or so, a log scale really should be used because even benign annual increases turn into near-vertical rises by the time you get to the right side of the chart, depending upon the time period.

The log scale chart below clearly shows that the current commodities boom - as measured by the Reuters/Jefferies CRB Index - still has a long way to go before it equals the one from three decades ago.

Of course, the most important aspects of the last two charts - what no one really wants to talk about today, particularly in Congress - are the fundamental changes that occurred in the U.S. currency around the time that commodity prices began to rise.

Back in the early 1970s, the Vietnam War and spending for social program caused President Nixon to close "the Gold Window," forever severing the link between the U.S. currency and anything tangible.

Since 2002, after the stock market bubble had burst and 9/11 temporarily shattered the confidence of an entire nation, a new round of currency debasement got underway, one that accelerated last summer when the credit crisis began.

Congress need look no further than Washington D.C. to find the answers they seek.