Commodities Look Set to Rocket Higher

I've been asked to comment on the work of a few noted deflationists who are calling for a top in commodity prices here. Their argument is pretty clear cut: Because inflation is a function of available money plus credit (their definition), and because credit has fallen, deflation is what comes next. When looking about for things to deflate in price, commodities are an obvious candidate for attention because they have risen so much over the past decade.

In this view, three things have to be true:

  1. Demand for commodities has to fall below supply. After all, as long as demand exceeds supply, prices will typically rise.
  2. Money, including credit that would normally be used to buy commodities, has to shrink. That's the definition of deflation that we're analyzing here.
  3. People's preference for money has to be greater than their preference for 'things,' with commodities being very obvious 'things.' That is, faith in money has to be there or people will prefer to store their wealth elsewhere.

These are all just versions of the old supply/demand argument for commodity prices, except that our consideration also includes the important element of the Austrian economic view of demand for money.

There are several reasons why I think there are serious holes in each of these conditions. Enough to warrant a healthy degree of caution in one's certainty about what 'must' happen next to commodity prices. Full disclosure: I continue to have 75% of my total net worth locked up in gold and silver, so I am decidedly in the camp that does not believe the commodity surge has yet run its course.

A Technical Challenge

Before we tackle each of those three conditions from above, let's look at the chart for the Continuous Commodity Index (CCI) to see what it might be telling us.

First, let's examine the period after the great bust of 2008 (a liquidity-driven event) and note that commodities essentially rose during all of 2009 and then formed a classic 'bull flag' formation in early 2010.

It should be noted that calls of commodity "topping" were also made at this time by several prominent deflationists. However, a topping pattern and a bull flag are very different beasts. So I was quite content to keep my calls for more commodity price increases intact at this time, even though they spent six months trending lower in this consolidating pattern, because the chart looked quite bullish to me. 

And I was watching the near-daily Fed injections of thin-air money into the system, reading about surging Chinese demand, and tracking our negative interest rates at the same time -- all features that are supportive of higher commodity prices.

Note also in the above chart that the RSI on top was in neutral territory and rising (green line above) and that the momentum indicator (MACD) was also rising (green line below), both of which are typically bullish patterns. None of this was at all consistent with topping. It doesn't rule a top out, naturally, in trading and markets anything can happen, but these are not the usual signs one expects at a top.

Now let's expand the chart out and see what happened next:

First, we might observe a 43% run-up in commodity prices over the next eight months following the bull flag we just dissected. Note that it is almost uninterrupted during the period from July 2010 to April 2011.

Second, we might ask ourselves what sort of a pattern we currently have in the commodity index chart. Rather eerily, because one rarely sees such a perfect repeat of patterns, what we see is another almost identical bull flag complete with rising RSI and MACD readings.

On the basis of these technical readings, I would be extremely cautious in making a call for commodities to spike down from here. Instead the chart is pretty clearly calling for another run to the upside. Again, this might not happen, and commodities could always fall from here, but a bet made in that direction is fighting a pretty powerful chart.  

Now let's turn to the fundamental reasons that support the idea of a bullish commodities chart.

Condition #1: Supply Exceeds Demand

A key component of the deflation argument is that with credit shrinking, demand will drop, leaving excess market supply that resolves with lower commodity prices. Housing in much of the Western world, for example, fits this definition nicely. Too much was built while prices ran too high, and the bursting of that bubble is now resolving itself through lower prices.

Commodities have a long and storied history of boom/bust/boom, with supply and demand alternately racing past each other as the lag times for developing new supply assure too much at some point and too little at others.

What's new in this story today is the emergence of a couple of new economic powerhouses with billions of citizens as new participants at the resource table.

India is one of them, and the recent 'bad news' out of there was that the Indian economy only grew at 7.7% in the most recent quarter:

Indian GDP growth slows to 7.7

August 30, 2011

India's economy grew 7.7% in the three months from April to June, compared with the same period of 2010.

It was India's weakest growth for six quarters, but still better than had been expected.

The manufacturing sector grew 7.2%, an improvement from the previous quarter, but well below the 10.6% in the second quarter of 2010.

While the 7.2% growth in the manufacturing sector was downplayed in most articles in comparison to the prior 10.6% growth, it is useful to remember that a 7.2% rate of growth translates into a full doubling over just ten years' time. In other words, in ten years, India's manufacturing sector -- the one that consumes lots and lots of natural resources -- will be consuming twice as much of everything as it does now.

It is this massive rate of growth that is eating into the world's remaining resources and creating competition for most basic natural resources.

As big as India is, and as fast as its rate of economic expansion is, it is dwarfed by China on both counts:

SINGAPORE/BEIJING (Reuters) - UBS cut its 2011 and 2012 growth forecasts for China on Thursday to reflect weaker growth prospects in developed economies, saying the central bank may relax policy if the world's second-largest economy falters.

UBS now expects 2011 gross domestic product growth of 9 percent, down from its earlier projection of 9.3 percent. For 2012, it sees GDP growth of 8.3 percent, down from its previous forecast of 9 percent, it said in a report.


Again, while the emphasis in this article is on weakening growth, we should also be sure to note the absolute rate of growth here. 

Global slump? What global slump? China is slated to grow its already huge economy by 9% this year (2011). If that rate of growth were sustained, China would double its economy in just eight years. Twice as much of everything would be consumed in just eight years.

When you are talking about 1.3 billion people doubling their intake of economic goods and services in just eight years, you are talking about the fastest absolute increase in demand placed on natural resources ever seen in world history. Faster and faster and faster; more and more and more.

What sorts of news items might we expect to accompany such a proposition? Perhaps some like these:

China's corn demand mindblowing

August 17, 2011

China's struggle to meet the growing demands of its middle class is fueling a sudden surge in demand for corn, sending vast ripples across the U.S. farm belt and potentially upending the grain's trade flows around the world.

China's need for corn -- which forms the basis of sweeteners, starch and alcohol as well as feed for livestock -- was on stark display in July when the nation ordered 21 million bushels of U.S. corn in one hit, more than the U.S. government thought the country would buy in a year. 

Corn prices, which have nearly doubled over the past year, climbed another 1% Tuesday. 

China's appetite for oil imports increases

BEIJING, Aug. 15 (UPI) -- China's dependence on imported oil grew to 55.2 percent in the first five months of this year up from 55 percent last year, reports state-run news agency Xinhua, citing figures from China's Ministry of Industry and Information Technology.

In 2009, however, China's dependence on imported oil rose to 33 percent.


China's Natural Gas Consumption Climbs 32 percent

Industrial Info Resources reports China's apparent natural consumption reached 11.1 billion cubic meters in July 2011, an increase of 32 percent from July 2010 and a 3 percent increase from June 2011, according to data issued by the General Customs Administration of China (GCAC).

As consumption increased, the import volume of natural gas also jumped from 15 percent to 25 percent over the same time period.

Securing uranium supplies still essential to China’s energy security

China has 14 operational nuclear reactors and according to the World Nuclear Association, 77 more reactors are either planned or under construction with aim toward increasing nuclear capacity to 80 GWe by 2020, 200 by 2030 and 400 GWe by 2050.

However, the nation’s domestic uranium resources don’t even come close to the amount needed to fuel such an expansion. To secure uranium reserves, China has been aggressively moving to sign supply contracts and joint venture mining agreements as well as to purchase uranium mines overseas.

By 2020, China is expected to account for 20 percent of global uranium demand, according to Resource Capital Research.

There are loads of similar articles covering China's aggressive expansion into Africa's resource plays, energy deals across the globe, and arable land where it is available. We're seeing exactly what you would expect from a major economy expanding like crazy:  a rapidly growing, or, shall we say, exponentially increasing hunger for natural resources.

Perhaps a slump in the Western economies will suddenly flood the world with enough resources to cause a commodity crash, but perhaps not.

A Paradigm Shift

The supply-and-demand argument rests on the time-tested notion that with increased demand, new supplies are brought to market. This has more or less always been true, although astronomical prices will not get you a passenger pigeon and rising prices seem unable to drag more giant Bluefin Tuna from the seas. The point there is that the usual supply and demand argument falls apart in the presence of limits.

Jeremy Grantham, who previewed my book last fall and provided a blurb for its jacket cover, has been all over the news lately talking about a profound structural shift in natural resources:

Grantham concludes that the world has undergone a permanent "paradigm shift" in which the number of people on planet Earth has finally and permanently outstripped the planet's ability to support us.

Specifically, Grantham says, the phenomenon of ever-more humans using a finite supply of natural resources cannot continue forever--and the prices of metals, hydrocarbons (oil), and food are now beginning to reflect that.

In other words, Grantham says, it is different this time.

Grantham believes that the trend of the last 100 years, in which the prices of almost all major commodities have steadily declined, is permanently over. And from here on in, humans will be competing more--and paying more--for ever-scarcer resources.

From a societal standpoint, the news is far worse. Grantham believes that the planet can only sustainably support about 1.5 billion humans, versus the 7 billion on Earth right now (heading to 10-12 billion). For all of history except the last 200 years, the human population has been controlled via the limits of the food supply. Grantham thinks that, eventually, the same force will come into play again.


Instead of oil being in a spiked-top formation ready to fall back to its prior range of $20-$30 a barrel, Grantham argues that oil has shifted to a new price level. I have argued the same thing, not by using price charts, but through the fundamental analysis of oil supply in the context of Peak Oil coupled with an understanding of the marginal cost of producing a new barrel.

If it costs $70 - $80 to produce a new barrel of oil, the price cannot fall much below that for very long. 

So on the first deflationist point that supply of commodities will soon greatly exceed demand, I have to conclude that until and unless we see China's and India's economies fall off a cliff, the impact of bringing an additional 2.5 billion consumers to the global buffet of natural resources will provide ample pressure to prevent a sustained crash in prices. Perhaps we'll experience a short-term correction, especially if the Fed is stingy with its still-unannounced QE III program, but a long-term crash seems highly unlikely.

Condition #2: Money Plus Credit Shrinks

The second key deflationist assumption is that the supply of money plus credit will decrease. Central to this argument is the idea that it's insufficient to track the money supply alone and that it's essential to include the expansion (and/or contraction) of credit as well. This makes sense on the surface, because credit allows people to buy things and buying can translate into price pressures. More credit means more buying pressure; less equals the opposite.

But I have a number of difficulties with this view over the long-term. (Hey, credit has to be paid back at some point, right? So it's roughly neutral over the long haul.) This explanation is especially problematic for me when it is used in an overly broad way by lumping all credit market debt into a single spot and then saying, "There. Look. It's fallen. Credit is down, and that's deflationary."

The trouble I have with this view is that not all credit has the same impact on demand. Some credit leads to demand that directly impacts the CPI (inflation), and some does not. When we are talking about inflation, what most people care about is the price of things they use or consume (cars, food, gasoline, health care, houses, etc.), rather than financial instruments or paper assets (stocks, bonds, derivatives, etc.)

Let's put it this way: If you give someone a billion in dollars in credit, it matters significantly whether they go out and buy ten thousand silos of corn or one twentieth of the next ten-year Treasury bond auction. In the latter case, nothing much happens to everyone else's inflationary experience, but in the former case, the price of corn goes up.  A lot.

In other words, credit extended within and among the financial community mainly flows within and among the paper assets of the world, while non-financial credit goes to consumers, businesses, and governments that use the credit to buy real things. 

[Note: One aspect of financial credit takes us to the world of shadow banking, where financial institutions and purely financially oriented participants buy and trade financial instruments generally just within and among themselves, often with tremendous leverage.]

Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn. Therefore it is important for us to separate credit into its financial and non-financial components. 

On this basis, if we look at total credit market debt broken out into its two main components (financial and non-financial), we see that instead of credit falling in general, it has fallen only in the financial world, but has climbed by an amount almost exactly offsetting it in the non-financial sectors:

Yes, financial-sector debt has fallen by $3 trillion, and that is a drag on total credit market debt, but as explained above, we wouldn't expect this to have much of an impact on inflation for anything other than paper assets. Non-financial debt, on the other hand...

...has rather steadily climbed uninterrupted before, during, and after the Great Recession. Credit market debt within the physically consumptive portion of the economy has climbed by nearly $3 trillion, almost perfectly offsetting the non-financial decline. But the offset is just an interesting observation that really tells us nothing about the inflationary or deflationary effect of credit expansion/contraction on the things that are tracked in the CPI.

So on the basis of credit alone, I find the deflationary argument to be weak. There's been $3 trillion of new credit created in the consumptive portion of the economy since the start of the financial crisis in 2008, and it's almost entirely thanks to government borrowing. Not too shabby.

Money, Money, Money

Turning to money itself, the deflationary argument becomes a lot more difficult to sustain. Money is measured by the Federal Reserve in various ways that are called the "M's." M1 is the narrowest version, representing cash in and out of the banking system and demand accounts (savings and checking) at the bank. Just look at M1 lately:

The increase in M1 since the start of the financial crisis (red box) is the same as the entire accumulated supply of money that existed in 1992 (green box). That is, as much M1 money has been created in the past three years as was created from the founding of this country through 1992.

It's really hard to square up that data with a deflationary argument. I have to assume that at least part of the reason for the big increase in M1 is people like you and me taking cash out of the bank, necessitating the printing and distribution of more cash.  

M2 represents a slightly broader definition of money:

M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs).


A chart of M2 reveals a steadily increasing rate of money creation that has been especially intense over the past few months:

There is absolutely nothing deflationary in the M2 chart. It is exactly what we would expect to see from a culture that placed a man at the monetary helm on the basis of his promise (Jackson Hole, 2002) to run the printing presses if deflation came knocking.

Because M2 includes time deposits, which are generally locked up (in CDs and such) and therefore not immediately available for use, and it excludes institutional money funds (that might be used to buy things), it might not be the best indicator of money that can trot out of an account and create inflationary pressures.

For a better measure, I prefer MZM, or money of zero maturity, which includes institutional money funds and excludes time deposits. Here's a chart of MZM:

Yes, there was a little wobble downwards in MZM right after the end of the last recession, but over the past two years (red dotted lines), we note that a trillion dollars in new MZM has entered circulation (blue dotted lines). Again we might note that it took all of US history until 1982 to create the first trillion of MZM money stock, but only two years for the most recent trillion.

But what about people's preference for money? In Part II: Why Commodities Are the New Safe Haven, we delve into the big changes afoot there, as well, which will assuredly influence the future direction of commodity prices. For those looking to preserve the purchasing power of their wealth, it's important to understand the growing momentum in the global mindshift away from paper assets towards more tangible stores of value.

Click here to access Part II of this article (free executive summary; enrollment required for full access).

This is a companion discussion topic for the original entry at

Nationaldebt just tweeted "NationalDebt: $14,694,862,366,160.97 (+) #nationaldebt" so the US is over the new debt limit again.  Did anyone notice this?
Also, did anyone read the ISM Non-Manufacturing Report for August?   Prices increased 7%!  Clearly commodity inflation is spilling over to the supply channel now in the product pipe.  Services are 90% of GDP but no news on this!


Chris, as usual a job well done.  I would offer that the massive increases in the various ‘M’s’ is the result of the Central Bankers of the world trying to stave off deflation.  As such, we are confronted with the half of the problem you articulated in your article - rising commodity prices.  This is a logical byproduct of the desire to own ‘things’ rather than currencies.  Unfortunately, the other side of the coin points solidly toward deflation for which, IMHO, the following is the end all;  we are in a balance sheet recession which will shortly turn into a depression.
Simply put, the asset side of the national balance sheet has been decimated while the liabilities have not been reduced meaningfully.  This has resulted in real estate prices collapsing while, oddly, the mortgages that funded this real estate still sit on the ledgers of the banking system at par.  Put another way, the amount of income that can be generated by the remaining level of assets is no longer able to support the liabilities.  This will remain the case until the liabilites are reduced to match the current level of the assets.  However, if/when this happens, the global banking system will be proven insolvent.  Therefore, TPTB will do EVERYTHING and ANYTHING in their power to insure this doesn’t happen

As evidence of the deflation argument, I offer the continued decline in real estate prices and the fact that the 10 year Treasury bond traded at a yield of well below 2.0% most of yesterday.  This happened just more than 60 days AFTER the end of the Fed’s open market operations designed to LOWER interest rates.  Since the end of QE2 on June 30, 2011, the price on TLT (the iShares 20+ yr. Treasury ETF) has risen from about $93 to $112 today while the yield has fallen from around 3.5% to under 2%.

I would argue that the environment we are is is solidly deflationary overlaid with the specter of currency and/or sovreign defaults which is pushing commodity prices higher.  Like you, I expect commodity prices to continue rising as alternatives to currencies and for the demand issues you identified.



What happened to "The Coming Rout" that you were warning about all summer?

Have you really switched gears again so quickly?


 An absolute stunner… think it should be reserved for the subscribers only for at least 3 months … 

 The separation of credit money and "physical" t=0 money… crucial… and the analysis of how that impacts the commodity space…

 and within the commodities…   cough


  Separates the inflation/deflation boys from the men… !  



Thank you for your analysis and insights, Dr. Martenson.
It would seem that my models need major surgery.

I thought that the thin air money was ending up in the financial sector and just spinning it’s wheels. Meanwhile, back at the Ranch, the markets were being starved of cash and this caused the  increases in instability and price.

However, this graph shows a decrease in financial debt, destroying the model completely.

And this graph shows a (spectacular) amount of money going feral.

So my new model is that the money is being handed out at the ATM’s.

How about this? The financial sector is deleveraging and dumping this toxic asset (the dollar) onto Joe Bag-of-donuts.

But hang on there. The top graph shows the Debt carried by the financial sector. Perhaps they are syphoning off some of the flow of dollars to deleverage and then passing the rest off to the public. Perhaps we should consider what ratio is being kept in the financial sector.

Perhaps not. It is all too esoteric.

What should Joe do? I think Joe should be sly and pass the counterfeit notes on to his friends for real goods. (While keeping a dollar tucked into his shoe.)


Looking at the two graphs again I see that the financial sector debt is 14 trillion and the M1 money supply is about 2.1 trillion. About seven times the size. I guess that the greater part of the printed money is being held back by the financial institutes.
What does that mean? That the prime function of the FED money machine is to monetize the pretend assets on the financial institutions, (Failed mortgages).

OMG! I am begining to sound like an economist. I must stop before it is too late.


You know what you are?  I will tell you what you are.  You are the [expletive deleted] man!!! 

Finally... someone explains the DIFFERENCE between financial credit and non-financial credit to solve the mystery between increasing commodity prices in the context of deflationary credit (nobody I've asked has ever been able to explain this, because they themselves had no idea). This missing piece is finally solved for me... phew!

[quote=KugsCheese]Nationaldebt just tweeted "NationalDebt: $14,694,862,366,160.97 (+) #nationaldebt" so the US is over the new debt limit again.  Did anyone notice this?
I posted about this in Daily Digest 8/3…
Deja Vu All Over Again: Total US Debt Passes Debt Ceiling… In Under One Month Since Extension Tyler Durden 09/02/2011   Remember when one month ago the US, to much pomp and circumstance, not to mention one downgrade,  announced a grand bargain raising the debt ceiling from $14.294 trillion to something much higher, with a stop gap intermediate ceiling of $14.694 trillion, or $400 billion more.   Well, as of today, or less than a month since the expansion, total US debt is at $14.697 trillion.   Yep - the total debt is again over the ceiling, which means the US debt increased by $400 billion in one month. Score one for fiscal prudence. And while the total debt subject to the limit is still slightly less, at $14.652, one week of Treasury auctions and will be time for Moody’s to justify again why the US is a quadruple A credit.


I think Big Pharma has a pill for that. {wry grin}
Thanks for this breakdown Dr. Chris. Helping me once again to better understand the sitch. Viva – Sager

Stocks of commodity companies?

Hi Chris,
This was an outstanding report. Although one word I did not see you use is Stagflation. Because to me, we have a stagnant economy with rising prices.

As an example of price inflation, the other day, I poked around to see what the local heating oil prices were, and it occurred to me that if these prices were to hold through the winter, then this will be the costliest year ever for those of us heating with oil.

I have been comparing the performance of gold with everything else over the last three years.  I discovered something which to me was extraordinary:  Over the last three years gold has outperformed every stock, every bond fund, every mutual fund, & every index I can think of – except for silver.  (No doubt I missed many comparisons.)  I give a special mention to gold vs. commodities ($CCI):  For 2009 & 2010 gold & $CCI performed similarly.  However, so far in 2011 in gold has outperformed $CCI.   All currencies are being debased.  I see precious metals as the only refuge for preserving purchasing power given the continual debasing of all currencies around the world.      

John Williams showed recently that the spike in M1 and M2 is due to entities moving out of M3.   He stated that this is sign of forthcoming credit freeze ala 2008, ie moving into more moveable money.

Really great analysis Chris.
Thanks so much.

I have followed Jeremy Grantham and his company, GMO, and am thinking of investing in the fund it manages under Wells Fargo.  He seems like one of the few wealth managers who worries about peak everything and cares about the environment. If you’d rather have some money working for something instead of parked in gold, you might do the same.  He’s also an ethical gentleman in a business sector with too few of them.  Here’s a good NYT piece on him:

There are also a couple of audio presentations in podcast form on iTunes, just him talking about his investment strategy and fielding questions. Search for his name in the podcast directory.

Zach - Kunming, China

 Dr. M,
What about M3, as calculated by

Here are Mr. Williams’ thoughts on M3:


While M3 is not the perfect money measure, it is the broadest and best practical measure that currently is available, although no longer from the Federal Reserve.

...and I explain my preference — indeed the necessity — for using the broadest money measure available as an indicator of future inflation. While money supply measures M2 and M3 have a fairly strong correlation, the broader M3 provides the most comprehensive picture of what is happening to money in the system.

Why didn't you include the broadest measure of money supply in your argument? Perhaps it lacks the visual punch that your charts provide, but at first glance it does seem to correlate well with price inflation over the last decade. 

And what about this statement from you:

In other words, credit extended within and among the financial community mainly flows within and among the paper assets of the world, while non-financial credit goes to consumers, businesses, and governments that use the credit to buy real things.

Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn.

Are you really claiming that investment banks have no influence on consumer prices? That the paper derivitive markets have no effect on the pricing of real things? 

I mean, compare the price action of the food commodities that are traded in the paper market to those that are not, and you will see that financial community is very much a player in rising prices. And the housing bubble is a great example of how the derivitive markets influence the price of real things.

The whole inflation/deflation debate is really akin to the fable of the blindmen and the elephant. Everyone’s experience and interpretation of the market (the elephant) is accurate, yet incomplete. In an attempt to explain what we perceive is occuring (or will occur) in the market, we create elaborate rationalizations, when the truth is much simpler: everything that happens in the market is driven by the pursiut of profit, Period.

JAG…I see what you are saying about derivative markets having some impact on real goods costs, but I speculate that perhaps only in relatively few areas (and relatively limited dollar quantities) do they really create money velocity friction in the consumer markets as compared to increasing dollars of direct spending. 

You state: "Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn. Therefore it is important for us to separate credit into its financial and non-financial components."
It has been documented in the past that financial players are using credit to play in the commodities markets. There is also hoarding going on with sovereigns:

You also state that non-financial credit has not fallen. If I recall coorectly, the only consumer credit that has expanded has  been student loans (which can’t be expunged in bankruptcy, how nice) and possibly auto loans (which have become the new subprime credit driver).

It all boils down to whether or not the Fed ultimately prints enough to offset all the bad debt that can’t be paid. Political pressure is already causing them to hold off on QE3 in my opinion. While there are currently no legal restrictions that would prevent them from doing so, I believe that ultimately their power will be taken away from them and they won’t be able to keep up with the flood of defaulting debt.


As a new posting member… welcome.  I think you make some good points regarding credit… surely it can have some effect on commodities through speculative channels… the question is how significant? 
When you speak of the FED, saying, "While there are currently no legal restrictions that would prevent them from doing so, I believe that ultimately their power will be taken away from them and they won’t be able to keep up with the flood of defaulting debt."
What do you mean by this?  How do you imagine the FED’s power will be taken from them before the system crashes and burns in some kind of inflationary criticality?  I don’t get it.  Ron Paul 2012?