If you are interested in commodities, which has been a hated and neglected asset class since 2008, you will like the following chart I shared at the 2018 World Outlook Conference attendees:
This chart—comparing the US dollar index (top) to the Thomson/Reuters commodities index (bottom)—tells us some important things about commodities and the US dollar:
- Commodities prices are highly negatively correlated to the movement of the US dollar. I.E. when the US dollar index value goes up, commodities prices go down; and vice versa.
- There are cyclical trends (measured in years) in the US dollar, which are triggered by major global macro events; thus, by association, there are cyclical trends in commodities triggered by the same global macro events.
Let’s dissect this chart a bit further and then drill-down more closely on timing the next major multi-year rally in commodities.
Working from left to right on the chart above, we have effectively completely four different macro cycles and are now in the fifth cycle:
- China Symbiotic – The period when China couldn’t buy enough commodities to satiate its demand--driving commodities prices up sharply (or to put it another way—the real value of commodities rose relative to the “dollar” price of commodities). Thus, the see-saw. Remember there is a real economic relationship between the dollar price of commodities. Commodities represent real value i.e. tangible goods. And most commodities prices are denominated (traded around the world) in US dollar. Therefore, if the real value of commodities goes up, the relative price of the US dollar tends to go down; i.e. it costs more dollars per unit of commodity value; and vice versa. I hope that makes some sense. It is why I refer to it as a see-saw relationship.
- Credit Crunch – The credit crunch was the major global macro event of our lifetime and changed the dynamics for all traded global asset classes. As global consumer demand everywhere was crushed by the credit crunch, it hammered Chinese export growth and their corresponding demand for commodities. Thus, the fall in demand for commodities—pushing prices lower—also corresponded for an increased demand for the US dollars as both individuals and institutions clamored for US$ liquidity; it triggered an end to the US dollar bear market (dated from 2001) and signaled a new bull market ahead.
- QE Reflation – This was a period of renewed optimism for commodities on the expectation global central bank coordinated quantitative easing would liquify markets and stimulate global growth once again. Many believed it was a return to the China Symbiotic cycle from 2000-2007. The dollar fell again and tested its bear market low, but held above.
- New Abnormal -- But a funny thing happened: the global economy didn’t respond to all the quantitative easing and low interest rates; instead global growth stagnated. Central banks learned a hard lesson: If households and businesses are still recovering from too much debt load (cleaning up their balance sheets), they will not borrow money and spend, no matter how low the rate of interest on loans. “You can lead a horse to water but you can’t make him drink.” Slow global growth, means lowered demand for commodities, which was coupled with massive oversupply and global manufacturing capacity, especially in China. All things real declined in value; all things financial went up in value. There is the see-saw again. This also reflects the fact that during periods of global deflation, the world reserve currency (the US dollar) tends to increase in value as money moves to the deepest capital markets.
- New Sherriff in Town – The US dollar began to decline just after President Trump (our New Sherriff in this story) was elected. And low and behold the hated asset class—commodities—started to increase in price. Given President Trump’s mandate on global trade (he wants a lower dollar); I believe we are now in the midst of a long-term bear market in the US dollar, which means a long-term bull market in commodities is underway.
So, do we jump in with both hands now and buy commodities? Well, maybe. But, based on my US dollar wave forecast, it may make sense to wait a few months. I suspect we will see a multi-week snap-back rally in the US dollar and corresponding decline in commodities prices; Mr. Market likes to wrong-foot market players before a major move. I have depicted the Wave pattern and timing for the dollar and commodities index in the chart below:
When the near-term rally in the US dollar is complete—several months is my best estimate (maybe October)—it will be time to get long commodities with both hands and hold on for the long haul. Because, if the next dollar bear market is true to previous form, we should see a new all-time low in the US dollar index; that means the other end of the see-saw will swing to fresh new high territory. I suspect commodities futures brokers will soon be back in fashion and leveraged commodities players with patience will make a whole lot of money. Stay tuned.
Black Swan Capital
13 February 2018