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There are people walking around the planet making the argument that the recent precipitous decline in the price of commodities (especially oil) portends a cyclical slowing in economic activity and rough seas ahead for the stock market.

It's a sensible argument, if one believes the basic laws of supply and demand. But more important than whether it's sensible, it strikes me as important to see whether the data offer reason to believe it's true.

With that goal in mind, I plotted the Commodity Research Board Index, which represents a fairly broad basket of commodities, against the S&P 500 going back to 1991. That's 15 years, and the extent of the data I have in my database.

There's about a +0.28 correlation between the price panes of the SPX and the CRB Index over the past 15 years (where +1 is a perfect correlation and -1 is a perfectly inverse correlation).


However, that correlation may be significantly attributable to the general rising trend in inflation. With the consumer price index up roughly 40% since late '91, some of the price appreciation in both the SPX and CRB Index is owed to the higher cost of just about everything.

But remember, the question of the day is whether falling commodity prices will prove to be rough on the economy and the stock market in a cyclical time frame. On a year-to-year basis, the correlation between the price of the CRB Index and the SPX is -0.17. That is, in a yearly time frame there's generally a modest tendency for the SPX to go up as the CRB Index is going down and for the SPX to go down as the CRB Index is going up.

The sensible thesis that rising commodity prices represent strong aggregate demand is slightly outweighed by the (slightly more) sensible thesis that falling commodity prices reduce businesses' input prices and help profit margins, which is good for, well, most people -- and the stock market.

But neither of these tendencies is very strong.

The strongest correlation I found in examining these charts is when the CRB Index is set ahead by 950 trading days, or just less than four years. (There are about 252 trading days per year.)


With the almost four-year offset, the correlation between the SPX and the CRB Index is a much stronger +0.60 over this period.

Is that meaningful or just coincidence? (Or is it what pioneering psychoanalyst Carl Jung would call a "meaningful coincidence?") Perhaps there is some significance in the four-year offset. If so, however, the four- and-a-half-year upside run in commodities through mid-2006 would portend a continuation of the stock market's rise until mid-2010.

This is not a definitive refutation of the "falling commodities are bad for stocks" thesis. I offer it not so much because it's valuable on its own, but because an objective look at the history of the CRB Index does not support that thesis and indeed, if anything, shows a slight bias in the data to the contrary.

One more point on this subject: It might be possible to take the position that the great stock-market bubble of the late '90s and the bursting of the bubble in 2000-02 goofed up the normally positive correlation between the SPX and the CRB Index -- that the normal laws of supply and demand, when not distorted by bubblicious asset prices, usually should establish a positive correlation.

Maybe. But if so, then isn't it just as likely that the 100% surge in the CRB Index from late '01 through the middle of '06 is a bubble that ultimately will burst, further distorting the "normal" positive correlation between the CRB Index and the SPX? (That is, what's good for the stock-market bubble is good for the commodities bubble.)

You can't have it both ways. If the stock market in the late '90s was a bubble (and in retrospect it clearly was), then we have to acknowledge the distinct possibility that the commodities boom has likewise been a liquidity-driven bubble. And that bubble is just as susceptible to distorting normal correlations in financial markets, both now and in the years ahead.

If too much liquidity in the stock market can change the implications of low commodity prices, then too much liquidity in the commodities markets can also change the implications of high (and then falling) commodities prices.

Because of the weak and variable correlations between commodity prices and the stock market in even the simplest of terms, I don't buy the theory that falling commodity prices imply trouble ahead for stocks. And I sure wouldn't sell on it, either.

Next time I'll look at what the Treasuries and Treasury inflation-protected securities markets have to say about just what the stock market is discounting in terms of economic growth and inflation.
Adam Oliensis is president of Dog Dreams Unlimited, a guaranteed introducing futures brokerage, and editor of the trading service The Agile Trader. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Oliensis appreciates your feedback; click here to send him an email.

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