Deflation And The Future
The year 2014 was the worst year for commodities in the past five and one-half years... since 2008 in the Great Recession.
Prospects for a recovery in commodities prices are not good: market expectations for inflation over the next ten years has dropped from 2.30 percent last January to 1.55 percent now.
Can economic growth be rising in an environment where commodity prices are falling?
In 2014, commodities had their worst year since 2008 during the fall of the US economy into the Great Recession. The S&P GSCI (formerly the Goldman Sachs Commodity Index) closed down 33 percent year-over-year. The Bloomberg Commodity index closed down by almost 17 percent. Not a good year at all.
Earlier in the current economic recovery, commodities seemed to be the darling of investors because the policy of quantitative easing on the part of the Federal Reserve seemed to spur on dreams, in the short run, of a bubble in commodity prices. Everyone seemed to want to take advantage of opportunity to make a lot of money.
Inflationary expectations in the United States… and elsewhere… rose as the Fed continued to pump money into the banking system.
Many investors were preparing for the "great inflation" that was to follow this Federal Reserve largesse.
A common measure of inflationary expectations, the spread between the yield on the 10-year US Treasury note and the yield on the 10-year US Treasury Inflation Protected securities (TIPS), a high was reached around February 2011. The expected 10-year compound rate of inflation built into the Treasury bond market was 2.65 percent.
To support this fear of inflation the price of gold peaked in early September 2011 around $1,900.
But, inflation did not seem to be forthcoming. The rate of growth of the economy remained tepid, at best, and the consumer price index used by the officials at the Federal Reserve weakened and seemed to remain around the Fed's target of 2.00 percent.
Then we got to 2014.
The inflationary expectations reflected in the Treasury bond market was at 2.30 percent on January 3, 2014. The S&P GSCI was 260.36 at the close that day. The price of gold closed at $1,223.6.
The S&P GSCI peaked for the year at 645.20 on March 14. Inflationary expectations in the bond market had dropped to 2.19 percent on that day, but the price of the gold was near its peak for the year of $1,383.2.
On November 11, 2014, the price of gold hit its lowest level for the year closing at $1159.4 and this occurred as inflationary expectations dropped under 2.00 percent closing the day at 1.95 percent.
The S&P GSCI dropped to 526.95 on that day.
The declines continued through the end of the year, with inflationary expectations dropping to 1.60 percent on January 2, 2015. The S&P GSCI continued to fall closing at 414.91 on the same day.
It is also interesting that the value of the dollar against the Euro followed a very similar pattern.
On January 3, 2014, the value of the dollar against the Euro was $1.36. But, on the same day that the S&P GSCI peaked, the value of the dollar against the Euro also peaked at $1.39. As mentioned above, gold also had risen to $1,383.2.
The day the price of gold was its lowest during the year, the value of the dollar had fallen to $1.24 and the S&P GSCI had dropped to 526.95.
On January 2, 2015, the value of the dollar fell to $1.20 as the S&P GSCI continued to fall.
The price of oil?
It was on a similar trajectory throughout the year. On January 3, 2014, the price of oil was $94.23 a barrel. On March 14, the price had risen to $98.91. On November 12, the price was $76.80 per barrel. And, on January 2, 2015 the price had fallen to $52.62.
And, all of this came with the renewed enthusiasm in the fourth quarter about US economic growth in 2015. Furthermore, the US stock market hit new peaks at the end of 2014, with the Dow Jones index reaching a historic high on January 26, 2014 and the S&P 500 gaining its new high on December 29.
But, the commodities indices continued to fall through the first full week of January 2015 with the S&P GSCI dropping to 393.85, the value of the dollar against the Euro falling below $1.18, and inflationary expectations in the bond market falling to 1.55 percent.
Inflationary expectations are low in Europe as well with the yield on the 10-year German bund falling to an unheard of 0.45 percent as the eurozone actually reported that prices fell by 0.2 percent for the full year of 2014. On January 3, 2014, the yield on the German bund was 1.94 percent.
The commodity markets…and the bond markets…are seeing something that economists are apparently not observing in their rosy pictures of 2015. I think that it is important for us to look at what is being conveyed to us by these markets and try to find the reasons why they might be wrong. If we cannot find any way to disprove the expectations being reflected in these markets, then I think we need to check out the rosy 2015 economic forecasts.
Maybe 2015 is not going to be as good as many economists are expecting it to be. |
