Inflation-adjusted commodities price performances
Outlook for oil, copper, gold, silver, and platinum
To paraphrase Einstein, not everything worth measuring is measurable and not everything measurable is worth measuring. The purchasing power of money falls into the former category. It is worth measuring, in that it would be useful to have a single number that consistently reflected the economy-wide purchasing power of money. However, such a number doesn't exist.
Such a number doesn't exist because a sensible result cannot be arrived at by summing or averaging the prices of disparate items. For example, it makes no sense to average the prices of a car, a haircut, an apple, a dental checkup, a gallon of gasoline and an airline ticket. And yet, that is effectively what the government does -- in a complicated way designed to make the end result lower than it would otherwise be -- when it determines the CPI.
The government concocts economic statistics for propaganda purposes, but our point here is that even the most honest and rigorous attempt to use price data to determine a single number that consistently paints an accurate picture of money purchasing power will fail. It will necessarily fail because it is an attempt to do the impossible.
The goal of determining real (inflation-adjusted) performance is not completely hopeless, though, because we know what causes long-term changes in money purchasing power and we can roughly estimate the long-term effects of these causes. In particular, we know that the purchasing power of money falls due to increased money supply and rises due to increased population and productivity. By using the known rates of increase in the money supply and the population and a 'guesstimate' of the rate of increase in labour productivity we can arrive at a theoretical rate of change for the purchasing power of money. This theoretical rate of purchasing-power change will tend to be inaccurate over periods of a year or less but should approximate the actual rate of purchasing-power change over periods of five years or more.
We've been using the theoretical rate of purchasing power change, calculated as outlined above, to construct long-term inflation-adjusted (IA) charts for almost two years now. Here are the updated versions of some of these charts, based on data as at the end of May.
1. In current dollar terms, the oil price peaked at just under $200/barrel in 2008 and at around $170/barrel in 1980. It is now only slightly above its 40-year average.
We doubt that oil will ever again trade below $50/barrel in nominal dollar terms. Also, the 2008 peak was almost certainly the secular variety, so we probably won't see the IA oil price trade above its 2008 peak any time this decade. If oil does make a new high in IA terms within the next few years it will be because of a major Middle East conflagration that greatly reduces the global supply of oil, not because of rising demand or geological limitations on supply.
2. As is the case with oil, in IA terms the copper price probably made a secular peak in 2008. As is also the case with oil, the IA copper price is now only slightly above its 40-year average.
Falling demand due to a global recession over the next 12 months could cause the copper price to drop back to $2.00, but we doubt that it would stay that low for long because economic weakness always prompts central banks to boost the money supply. However, future rounds of QE (or whatever other name they give to the money pumping) probably won't do anywhere near as much for the IA copper price as the earlier rounds did. Another way of saying this is that copper probably won't be one of the main beneficiaries of future monetary inflation. One reason is that China's construction boom is turning to bust. Another is that the high prices of the past six years have increased the current and future supplies of this metal.
In 2012 dollar terms we think a copper price in the $2.50-$3.50 range is about right. We would therefore steer clear of copper mining projects that required a copper price of much above $3.00/pound to be economically robust and we would be wary of low-grade copper projects with unknown economics.
3. In early 2008, the combination of fear that electrical power shortages in South Africa would severely disrupt the global platinum supply and fear of Fed-sponsored dollar depreciation drove the IA platinum price above $3000/oz (about $2300/oz at the time, which is the equivalent of just over $3000/oz in terms of today's dollar). This will probably turn out to be a secular peak for the IA platinum price, although platinum stands a better chance than either oil or copper of exceeding its 2008 peak in IA dollars. There are two reasons for this. First, platinum supply is more concentrated and therefore more vulnerable to disruption than oil or copper supply. Second, we expect that platinum will benefit from the continuing upward trend in the IA gold price.
We may be interested in buying platinum if it drops to $1200/oz.
4. The IA gold price continued its long-term upward trend following a normal intermediate-term correction during the 2008 crisis. It is yet to experience a major upside blow-off like it did in the lead-up to its January-1980 peak and like the oil, copper and platinum markets did leading up to their 2008 peaks.
5. In nominal dollar terms, silver's April-2011 peak was a test of its January-1980 peak. In IA terms, however, silver's highest price in April of 2011 was only slightly more than one-third of its 1980 peak.
Silver's January-1980 peak was so extraordinary that it will possibly never be exceeded or even seriously challenged in IA terms, but there's a high probability that silver will handily exceed last year's peak in IA terms before its long-term bull market comes to an end. This is largely because although industrial demand plays a much bigger role in the silver market than in the gold market, investment demand is still the primary driver of silver's long-term bull market. Furthermore, the same factors that should continue to boost the investment demand for gold (government and central bank stupidity in all its forms) are likely to do the same for silver.
6. Because the official "inflation" indices chronically understate the reduction in currency purchasing power, using these indices to calculate inflation-adjusted performance overstates the performance. That's why Malthusians such as Jeremy Grantham are able to use CPI-adjusted charts of the CRB Index to support their theories that the world is about to run short of valuable agricultural and industrial commodities. These CPI-adjusted charts suggest that the ultra-long-term downward trend in "real" commodity prices has ended, an implication being that commodity supply is now in a long-term downward trend relative to real commodity demand.
The picture is very different if our preferred method is used to adjust for the effects of inflation. As illustrated by the following chart, the IA CRB Index made a new all-time low in 2001 and then peaked in 2008 at well below its 1974 and 1980 highs. There is no evidence that its long-term downward trend has ended.
Inflation-adjusted commodities price performances
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