Commodities Can't Measure Inflation

The 19th of October will be etched in traders' memories forever for two reasons. The first is the Crash of 1987; the second is an unusually lively -- what the diplomats might call "frank and useful" -- Columnist Conversation exchange on that date last week.

The question before the house is whether commodities are a good measure of inflation. At first blush, this might seem to be a riddle on the order of "Who is buried in Grant's Tomb?," but the answer is rather surprising.

The Long View

Let's take some very long histories of various cash commodities and deflate them by the producer price index, which I've presented in the chart below. I've used monthly averages of the cash market prices both to avoid single-day outliers and the contract roll problems associated with futures markets. All data presented in the chart below go back to 1946 except for coal (1984), aluminum (1951) and natural gas (1976). You may wish to keep in mind that the world's population has more than tripled since 1946.

Two indices, the Reuters/Jefferies Commodity Research Bureau (CRB, 1956), and the Journal of Commerce-Economic Cycle Research Institute (JOC-ECRI, 1971) are presented as well. As a rule, I do not like the entire concept of commodity indices because they involve combining negatively correlated assets, but even these measures have not shown long-term uptrends. The CRB data since June 2005 are colored differently to note the change in index composition.

Click here for larger image.

Source: Bloomberg

Individual Commodities

If we regress individual inflation-adjusted commodity prices against time, we should see positive coefficients for those commodities whose prices on average rose faster than the PPI and negative coefficients for those commodities whose prices failed to keep up with inflation.

On the chart below, the coefficients are color-coded into groups: Black for grains, brown for renewable industrials, gray for indices, light blue for industrial metals, green for livestock, red for energy and magenta for precious metals. Platinum is dual-coded to reflect its industrial and precious metal duality.

Click here for larger image.

Source: CRB-Infotech CD-ROM, Howard Simons

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