Tags: Commodities | GSCI | dollar | inflation

Rise of the Commodities: Part II

By Tom Hutchinson
Friday, 05 Oct 2012 07:53 AM Current | Bio | Archive

Last decade witnessed an unprecedented boom in commodity prices. While prices today are generally below the highs of last decade, they might be poised for a second epic rise that will be perhaps even more stunning.

The Standard & Poor’s GSCI is considered a bellwether for commodity prices in general. The index tracks 24 different commodities across five different categories: energy, industrial metals, precious metals, agriculture and livestock.

Between 2002 and 2008, the index soared an astounding 340 percent from under 200 to almost 900 (it's currently about 650). Some of the components moved even more than that. For example, crude oil prices went from $20 per barrel in 2002 to over $140 by 2008.

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Why did commodity prices rise so far so fast?

There were two huge driving factors: increased demand and a weaker dollar. Emerging markets such as China, India and Brazil exploded onto the world economic scene last decade, escalating world trade and commodity demand to a level never before seen. The global exchange of goods increased nearly 80 percent just between 2005 and 2008, according to the World Trade Organization.

Meanwhile, because of increased debt, escalating trade deficits and the Federal Reserve's low interest rate policies, the dollar index plunged 40 percent between 2002 and 2008. Commodities are priced in dollars and the dollar's fall relative to other currencies helped catapult commodity prices even higher.

Then came the financial crisis.

Commodity prices fell like a rock amidst plunging demand for commodities during the global financial meltdown. The dollar index soared as money fled to the relative safety of dollar-based assets amid the panic. But as panic waned and economies began to recover in 2009, commodity prices rebounded. The S&P GSCI recovered all the way back to about 750 (from a low of about 300 in 2009) by the spring of 2011.

But in 2011, the main drivers of commodity prices began to reverse. The global economy began to slow as the European crisis unfolded, reducing demand for commodities. And the falling euro helped prop up the dollar's value on a relative basis. So, the rise in commodity prices has been temporarily halted, for the most part.

But another powerful force has been unfolding that could send commodity prices into the stratosphere in the years ahead. Central banks throughout the world have been taking unprecedented actions to revive slowing economies that could severely devalue currencies in the future. The stage has been set for an inflationary environment so severe that the value of hard assets could soar even further than they did last decade.

Last month, the Fed announced the most aggressive quantitative easing (QE) program yet, QE3. This Fed action, which involves buying bonds from banks with newly printed money in order to spur the economy, will, by some estimates, inject as much as $2 trillion more into the financial system. Earlier programs (QE1, QE2 and Operation Twist) have already put about $2 trillion of new money into the system.

But most of that money has never made it into the money supply because banks aren't lending out the money. At some point, if the economy ignites, all that dormant, newly printed money could make its way into the money supply very quickly. Such an event would be a recipe for rapidly rising inflation.

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If the economy doesn't gain steam, it could deteriorate, as the debt continues to escalate and we have a European-style crisis and a devaluing of the dollar.

Either way, the danger is severe. However, inflation is unlikely to increase in a meaningful way in the immediate future. While the stage has been set for rising prices, they probably won't rise yet because the global economy is still in the dumps. But stay tuned. When circumstances change in the not-too-distant future, it will be the rise of the commodities part II.

About the Author: Tom Hutchinson

Tom Hutchinson is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of The High Income Factor. Discover more by Clicking Here Now.

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TomHutchinson
Last decade witnessed an unprecedented boom in commodity prices. While prices today are generally below the highs of last decade, they might be poised for a second epic rise that will be perhaps even more stunning.
Commodities,GSCI,dollar,inflation
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2012-53-05
 

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