Martin Pring On Why The Libyan No Fly Zone Has To Be Extended To Bernanke's Helicopter

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Another set of relevant obseravtions into commodities from Martin J Pring of Pring Turner Financial Group, courtesy of Advisor Perspectives.

There has been a lot of talk about the
excessive loose monetary policy coming out of the Federal Reserve.
However, most of the  arguments concerning the implications take the
form of generalizations as opposed to quantifiable relationships. Our
objective here is to show, through the historical relationship between
short-term interest rates and the economy, that the Fed has been overly
generous. Moreover, we will see that the data call for much higher
industrial commodity prices before this cycle runs its course. In
retrospect, they will make today’s elevated levels look benign by
comparison.

Chart 1 Commodity Prices, Short-term Interest Rates and the Economy

The bottom panel in the first chart shows our Growth Indicator, a
composite economic measure that flags whether short-term interest rates
should be rising or falling. Above zero readings tell us the Growth
Indicator is signaling that strength the economy is consistent with
rising rates. These periods have been flagged with the green highlights
on the actual 3-month commercial paper yield plot in the middle panel.

 The pink shading indicates when the Growth Indicator, our proxy
for demand, is signaling that rates should go up but instead they move
sideways or decline. The reason for that is the injection of excess
liquidity on the supply side by the Fed, which has yet to conclude that
inflation is the problem. In effect the central bank is keeping rates
below their natural level. The result, if you look at the CRB Spot Raw
Materials in the top panel, is an above average rise in commodity
prices. Compare that to the 1958 and 1981 periods when the rising black
commercial paper yield indicates the Fed was ahead of the curve. The
result, a benign commodity rally.

 The yellow shading starts when, after one of these overly
generous Fed periods or pink shaded areas, the rate starts to move
above its 12-month MA, i.e. the red dashed line. Yellow shading
continues until the Growth Indicator moves decisively back below
zero i.e. indicating a weak economy. You can see that during these
yellow periods, when the central bank is playing catch-up, commodities
really start to take off on the upside. There are no exceptions. As we
approach May 2011 rates are still below their MA and the Growth
Indicator is not only in a rising trend, but at a pretty overheated
level. Commodities are rising sharply and we have not even made it to
the yellow zone yet! Notwithstanding intermediate corrections along the
way, these conditions tell us that commodities are ultimately headed
significantly higher.

Chart 2 The Corporate yield Curve, the CRB Spot Raw Industrials and the Growth Indicator

Let’s take that idea a bit further by taking a closer look at the 
relationship between the corporate yield curve (3-month commercial
paper/Moody’s AAA Corporate Bond Yield), commodity prices and our
Growth Indicator. The red arrows flag cyclical peaks in the CRB Spot
Raw Industrials since the mid 1960’s. They all have one thing in
common; they were preceded by some form of tightening by the central
bank as reflected by a rally in the yield curve as it moved towards a
state of inversion.  There are no exceptions to this rule, although
some peaks(1966 and 1984)  were preceded by relatively small yield curve
advances. In both periods though, the cyclical low in rates coincided
with a positive zero crossover by the Growth Indicator, as shown in
Chart 1. This indicated  that the Fed was in gear with economic
conditions. The current cycle has experienced a flat yield curve for an
extended period, not much different from the previous cycle. In
addition the  high and rising reading in the Growth Indicator is
another reason for expecting higher commodity prices in the period
ahead.

Chart 3 The Oil price versus the CRB Spot Raw Industrials

One of the important questions is, what does all this mean for the
oil price? Chart 3 shows it overlaid with the CRB Spot Raw
Industrials. There are some discrepancies, but in the last 10-years
both series have been very closely correlated. If that relationship
continues then oil too is headed substantially higher.

Unfortunately, there is no known technique for consistently
forecasting the magnitude of a price move. However, when a market has
been in a trading range for a while market technicians use measuring
objectives.

 

Chart 4 Crude Oil and Long-term Momentum

In this respect Chart 4 shows the recent trading range for the oil
price. The objective is measured by calculating the depth of the
pattern, in this case the arrow on the left, and projecting this
distance in the direction of the breakout, that’s the arrow on the
right. As you can see, this measuring device calls for a rally to the
$220-5 area. Since prices often move in multiples of the objective, and
the global economy is consistent with significantly higher commodity
prices, that may turn out to be a conservative number. Consequently,
$225 is not a forecast, merely an intelligent possibility based on a
combination of technical objectives and economic momentum.

Some people say that there is no need to raise interest rates
because commodities will soon fall of their own volition. Chart 2 
debunks that idea because there is no instance in 50-years of history
when a commodity peak has not been preceded by a tightening in the yield
curve. Looked at in another way short-term interest rates remain flat
and no dynamic commodity rally has been halted by such a condition.
It’s like saying the fire will burn itself out when someone is still
throwing gasoline on it.

There are two inescapable conclusions from this data. The first is
that interest rates and commodities are headed much higher. The second
is that the Libyan  no fly zone needs to be extended to include Ben
Bernanke’s helicopter.

h/t Adam