Commodity Prices are rising but government bond markets can only think of deflation and disinflation

4th August 2010 by Shaun Richards

Following on from the recent signs of weakening in the US economy we got some more economic evidence on this front yesterday. Pending home sales were -2.6% and were followed by factory orders of – 1.2%, just to add to the gloomy picture the figures for June durable goods orders were revised down from -1% to -1.2%. The figures for both personal incomes and personal expenditures were flat leaving personal savings at 6.4%. All of these were worse figures than expected but the one that caught my eye was the personal savings rate figure which is quite a change on the pre credit crunch era. also it is edging higher. This has two effects firstly it takes demand out of the economy and secondly it may provide at least a partial explanation for the surprising levels of government bond yields I have written about recently.

One instrument that is being affected by the recent poor figures on the US economy is the US dollar. I wrote yesterday about its fall against the pound to 1.593 but it is also now at 1.32 versus the Euro and 85.53 versus the Japanese Yen. This leads me to two main thoughts. The first is that we have a partial explanation for the weakness in the Japanese Nikkei 225 equity index as the strength in the Yen affects Japans exporters. This trend which has pushed the Yen near to what would be a 14 year low also to my mind is an explanation of why the Nikkei fell by 204 points overnight to 9489. This means that the difference between it and the Dow Jones Industrial Average has risen to 1147 points or 11.7% of the Nikkei’s value. The second is how quite the news media have been on the fall of the dollar versus the Euro. It was not so long ago the Euro’s fall was being trumpeted in some quarters as being a signal for the end of the euro zone, on the same logic the euro zone should be benefitting from articles praising it.

What is happening with Commodity Prices?

This factor has come to my mind as we have seen rises in several commodities recently. The financial press is currently looking at the recent rises in the price of wheat which due to a severe drought in Russia which is apparently the worst for a century and too much rain in Canada is rising because it expects a shortfall in supply. On Monday the price of wheat rose to above $7 for a bushel of wheat before closing at $6.93. Looking at the year so far wheat prices fell up until June and since then have risen so reports of a 60% rise since June need to be taken with a pinch of salt. However we are up now from around $5.50 at the beginning of the year.

This move by wheat comes on top of recent rises in the price of sugar which has risen by around 38% over the past two months. We have also seen movement in the price of cocoa and the rather extraordinary move by one investor to control 7% of its supply. Coffee prices have also risen by around 30% this year.

The Commodity Research Bureau Index

Seeing moves in individual markets makes me take a look at the spot index calculated by the CRB which is a measure of overall commodity prices. The CRB calculates a spot index which has the following components in it.

Metals: Copper scrap, lead scrap, steel scrap, tin, and zinc.

Textiles and Fibers: Burlap, cotton, print cloth, and wool tops.

Livestock and Products: Hides, hogs, lard, steers, and tallow.

Fats and Oils: Butter, soybean oil, lard, and tallow.

Raw Industrials: Hides, tallow, copper scrap, lead scrap, steel scrap, zinc, tin, burlap, cotton, print cloth, wool tops, rosin, and rubber (59.1%).

Foodstuffs: Hogs, steers, lard, butter, soybean oil, cocoa, corn, Kansas City wheat, Minneapolis wheat, and sugar (40.9%). 

In case you were wondering (like me!) burlap is a type of hessian so it is a measure for rope/cloth. However the index has been calculated in its present form since 1986 with a small modification in 2003 to the definitions for zinc and copper. So it has a track record. It is not perfect in the way it is constructed but the methodology is to pick raw material prices as explained below.

The commodities used are in most cases either raw materials or products close to the initial production stage which, as a result of daily trading in fairly large volume of standardization qualities, are particularly sensitive to factors affecting current and future economic forces and conditions………

It does this as it feels that these will be the quickest to change as economic circumstances change. For those unaware of what a spot price is then.

A spot price is a price at which a commodity is selling for immediate delivery

So we have now an index which is a measure of price pressures at the beginning of the production/food chain. There are other variants of the same thing but the spot price is the most basic.

What is it telling us?

On Tuesday the spot index rose by 4.87 to 440.48. If we look back the recent low was just below 300 in December 2008. Over the past year the spot index has risen by 18.3%. Prices in this series ebb and flow to a degree as commodity prices are often volatile but the recent move upwards began at the beginning of July. Furthermore since the middle of July the metals component has been a major contributor to the overall index rise as it has risen from below 720 and it continued this trend yesterday as it rose by 27.75 to 781.8. So it is not only foodstuffs which are rising.

There is no automatic link between a rising CRB index and inflation but recent movements do suggest that there are some inflationary trends in the system. This sits rather oddly with the current world obsession with deflation and disinflation to my mind. I do not see why stagflation as a possibility has been ruled out by so many.Perhaps they have been staring too hard at their output gap theory charts again, a theory which in the UK has performed poorly over the credit crunch and if you look at my update on US inflation on the 2nd July may not have performed so well there either. Perhaps they have been looking at the worlds major government bond markets and their yields.

Government Bond market yields seem to be predicting deflation and perhaps disinflation

The counterpoint to the fact that the world does appear to have some inflationary trends in its system is the behaviour of government bond yields. I have written about this each day this week but today the moves come as a counterpoint not to equity markets (although to my mind the point remains true) but to commodity price trends. Over the period commodity prices have been rising so have government bond prices.

Yesterday the yield on ten-year US government debt fell to 2.89% and the ten-year UK gilt yield fell to 3.28%. The yield on two-year US government debt is now 0.53%. Now some of this is being driven by expectations of a move towards some more monetary stimulus measures by the US Federal Reserve on August 10th but the way that yields are being driven lower is quite remarkable. If the famed double-dip does not occur then this will be looked at in history as an extraordinary bubble in bond prices.

As ever the most extreme example of this is Japan where this morning something happened which even in the fevered state of bond markets and allowing for her prolonged period of disinflation surprised me. Her ten-year government bond yield touched 0.995%. For those who do not follow her fiscal position she has an extraordinary amount of issuance to undertake this year of around 50% of her Gross Domestic Product and yet this market ignores this and rallies.


The world picture at this time continue to be one where markets are fixated on what I call the “outliers” of probability. Whilst it looks as though the US economy is slowing this does not guarantee it will fall off the edge of a cliff as government bond markets are assuming. If it does not fall off the edge of a cliff many recent bond purchasers are going to regret their purchases.

The deflationary/disinflationary side of the argument does not have any room in it at all for the recent rise in commodity prices. Now this is a complicated picture because as these commodities are priced in US dollars  the falling US dollar will help everyone except the US deal with this. Then of course you have world equity markets whose recent rally gives a completely different picture.

Overall maybe the clearest message is one of confusion and uncertainty as each market appears to be predicting a different outcome.

4 thoughts on “Commodity Prices are rising but government bond markets can only think of deflation and disinflation”

  1. Drf says:

    Hi Shaun,

    When you write “There is no direct link between a rising CRB index and inflation…” Surely that depends upon what you believe inflation is defined as? You have previously written that you accept the definition of inflation which you were taught when you studied at LSE, namely that which originally was called “price inflation”. Surely if you accept that definition of inflation then there is indeed a very correlated link between a rising CRB index and inflation, since rising commodity prices will cause price inflation to rise?

    On the other hand if you accept the classical original definition of inflation, then your statement is true. As I have pointed out previously, this is one of the problems which arise from attempting to supposedly measure inflation by monitoring price changes only. You continuously get completely misleading and erroneous results.

    1. Hi Drf
      Thanks for pointing this out. I agree that direct was not the best choice of word for what I was trying to say and have changed it to automatic.

  2. Diemen says:

    Thank-you for your efforts in writing your blog, always very interesting and informative. Although I have many opinions and thoughts, I have never dared reply, as my economic back-ground is limited only to running a number of commercial businesses in the UK. I am today, in my capacity of working in agriculture, able to offer a little light on the wheat prices at the moment.
    You correctly highlighted the fall in prices in June, which exagerate the rise in the price of wheat as a %, but the price movements I fear, are looking to mirror some of the factors that saw commodity prices in general, and wheat, rise in 2007. Politics and sentiment are having more of an effect on prices than actual supply and demand figures.
    General wheat production in the world stands at 650-700 million tonnes per year, with consumption very near these figures. Last years harvest added to the global stocks of circa 180-200 million tonnes. So why, with this stock carry, are we seeing prices rise by such a %? These world wide stocks are being strategically held by Country’s, and the result is speculation of supply. This year’s global harvest may be down, but not to the levels at which the speculation is trading on.
    One point that I would like to offer is the elasticity of demand of staple food products to price changes. One might assume that there are so many mouths in the world, (and getting larger), all needing to be fed roughly the same amount. Following the the prices rises in 2007, the consumption levels of grains across the world contracted by a large %.
    I may be looking to forward sell all my grain for next year’s harvest at these high prices, as I am sure we will see prices fall next year. Not that the media would ever tell the consumer that prices are going down for a change!!

    1. Hi Diemen thank you for the compliment and welcome out of lurkdom!

      It is interesting that you highlight speculation as a possible cause of this move. This has been prevalent in commodity markets before and in more recent times the rally in oil for example up to US $140/150 looked like it had speculative elements as has the recent purchase of 7% of the cocoa supply. Usually it comes down to liquidity and the more liquid a market the less easy it is for speculation to push or pull it around.
      On the issue of the general media I agree that they often only look at one side of the coin. I return to subjects every now and then to look to avoid doing the same, for example highlighting the rally in the Euro and the fall in government bond yields over the last week or so in the peripheral members of the euro zone. Good luck with the sale of the grain.

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