Wednesday, November 04, 2009

Reflections on Commodity Strength and the Macro Investment Picture

While stocks have pulled back in recent days, we continue to see firmness in commodities (DBC; top chart), especially gold (GLD; middle chart) and oil (USO; bottom chart). In a contracting world economy, we would expect commodity consumption to be lower and commodity prices to collapse. This would put pressure on the currencies and stock markets of commodity-producing nations.

In an expanding world economy, we would expect to see rising commodity prices, reflecting growing consumption of commodities especially by rapidly growing emerging countries. That should be supportive of the currencies and stock markets of commodity-producing nations.

The commodity markets at present speak more to the possibilities of runaway growth than to economic contraction. This is one reason commodity producer nations such as Australia and Norway have hiked interest rates: their concerns are for inflation, not deflation. Meanwhile, the U.S., U.K, and Japan find themselves staving off economic weakness with continued monetary ease and fiscal laxity.

I continue to believe that the relative stock market performance of emerging markets (EEM) to established markets (SPY), as well as the performance of commodity markets, will be excellent gauges of anticipated global growth. As long as the U.S. has to transition from a consumer/consumption economy to an export-driven economy, we should continue to see a falling U.S. dollar over time and no rush to raise short-term interest rates. Once that transition has taken hold, we could expect to see a sustained steepening of the yield curve for Treasuries and more serious concerns over inflation.

If this scenario continues to unfold, it is difficult to make the case for concentrating one's assets in U.S. equity and debt markets: headwinds of a falling dollar make those investments questionable relative to the assets in growing countries with relatively strong currencies and firm-to-rising rates.