Why the Bull Market in Commodities Isn’t Over

There is important news. And there is entertaining news.

Friday's most important story comes to us from the Financial Times:

"Biggest dive for commodities in 28 years," says the headline. It is important because it is likely to give people the wrong idea.

Oil dropped another $2.74. Clearly, the peak has come and gone. The black goo hit $147 and has been in retreat ever since.

Gold is down too. It rose $10 yesterday, bringing the price back to $922. For a moment, it looked as though we'd have a chance to buy below $900. But the yellow metal is fighting hard to stay above the $900 mark.

All across the archipelago of commodities prices are falling - from the base metals to the precious metals, from the softs to the hards, with all the mushy in between.

"All these gold bugs are back where they started 28 years ago," said our colleague Karim Rahemtulla in Vancouver. "The price of gold is barely higher today than it was in 1980. They haven't made any money at all."

After gold hit a peak of $850 in 1980, it promptly fell back...and kept falling for the next 20 years. Oil had a similar trajectory. It hit a high in the early '70s...and it, too, fell for about two decades.

Karim, and a lot of others, expect a replay.

They may be disappointed. The biggest dive in commodities in 28 years could be just a splash, not a sinking.

What marked the end of the last commodity boom was a major change in the monetary picture. Paul Volcker strode onto the scene and decided it was time for something different. Inflation rates were hitting 10%. And a relaxed monetary policy - allowing easy credit and more cash - was making the situation worse. "Stagflation" had become public enemy number one. When the feds tried to stimulate the economy out of the 'stag' part...they ended up contributing to the 'flation' part.

Of course, that is a big part of the picture today too. The feds are desperate to avoid any further bank failures or economic weakness. There are too many voters, too many Wall Street firms, and too many businesses in danger of failing. They're nationalizing the nation's housing...bailing out Wall Street...and holding the key lending rate at less than half the rate of consumer price inflation.

What can you expect? Well...stagflation!

Already, one estimate is that 144,000 retailers are expected to close their doors this year. Each time one goes broke, more people are dumped onto the job market. The latest figures show jobless claims reaching a 5-year high. Each month for the last 7, unemployment has gone up.

The 'stag' part is hitting the nation's eateries especially hard. Restaurants expanded too fast, say the experts. Now, they're contracting - releasing more low-income employees from taking orders and scrubbing pots and pans. And the airlines and automakers are suffering too. General Motors plans to lay off 15% of its work force too. GMAC, its credit arm, just reported a $2.5 billion loss.

Naturally, tax receipts are falling too. Net corporate tax receipts are expected to fall by $100 billion in 2009. Net individual tax receipts should fall by $100 billion too. Hey, a billion here...a billion there...pretty soon, the government is running a trillion-dollar deficit...

The economy is growing at a 1.9% rate, according to yesterday's report. That's less than economists had expected. The Commerce Departmen says it believes a recession may have begun in the last quarter of last year. (More below...)

Won't recession mean lower commodity prices...and the end of the bull market in gold and oil? Is this the end of the trend begun only a few years ago...the trend that took oil from $20 to $147...and gold from $260 to $1,000? Probably not.

Commodity cycles usually last 15-20 years. It takes a long time to open a gold mine or an oil field. At first, people in the business are reluctant to invest the money. They've just been through a long down- cycle, in which all their investments during the previous boom phase blew up on them. They've still got the powder on their faces and the burn marks on their fingers. When prices turn up, they're convinced that the upturn is merely temporary. Their models still project low prices. Their hedge books are still crowded with forward sales well below spot prices. And in their garages are still parked the same old cars they bought in the last boom.

But prices climb a "wall of worry," say the old timers. Then, after they have scaled the worries, they are sans soucis on top...and then so cocksure that they can't wait for the hand-grenade to explode on its own; they pull the pin themselves - investing and spending recklessly, sure that prices will continue to rise forever. It's when that last stage comes that you really have to watch out... That's when gold, oil, and the whole commodity complex comes crashing down...and doesn't revive for another 20 years.

We doubt we're there yet. But please don't confuse us with someone who knows what is going on. If we told you we knew for sure when this bull market would end - you should start reading some other commentary. Because your Daily Reckoning editor would be an even bigger fool than he thinks he is.

All we can do is guess. And our guess is that we are looking at a correction, not a fundamental change of direction. Not only has the cycle not lasted long enough to draw forth substantial increases in most basic commodities (with the exception of the farm commodities), the monetary cycle remains decidedly expansive. There is no Paul Volcker in the picture. Instead, there are Ben Bernanke and Hank Paulson. There are bailouts, deficits, and cheap credit...as far as the eye can see. Plenty of 'flation', that is, to go with the 'stag.' An article in the Economist, for example, says consumer price inflation will rise to 6% before the end of this year...

Bill Bonner
for The Daily Reckoning Australia

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