Monday, October 13, 2014

Deflation First, Then Inflation?

In this article, I would like to illustrate the case for a deflation (soon), perhaps later to be followed by an inflation (a possibly severe inflation).  Here, I am using the "popular definition" of deflation (prices declining) rather than the more correct definition of a deflation as a decline in the supply of money.  Economic history has shown that an inflation (or even hyperinflation) is often preceded by a deflation.  People are making the case now that we may have just entered a deflation phase, this is what I would like to examine today.

This article is "chart-heavy", and so illustrates weakening prices...  I am still not convinced that charts can help "predict future price movements" (technical analysis).  Also, please note that there are scale differences among these charts, interpret with caution!

I recently wrote about the US dollar being very strong lately, it has continued up, but this week has just turned down.  A strong US$ would likely negatively correlate (somewhat) with many commodity prices.  As always, *click* on any image for a better view.

Note the US$ is up about another 0.5% since my September article (recall that the US$ chart above is the US dollar vs. other currencies).  Keep this chart in mind as we look at below commodity prices.

I am going to examine some commodity prices that would support this case of deflation now.  I will later look at a pair of commodities "going the other way", that is, NOT supporting deflation now.

It is important to note that each traded commodity has its own "industry characteristics", its own patterns of production (supply) and usage (demand).  These characteristics will cloud this analysis, but if we find a general pattern across most commodities, that would tend to be supportive evidence that deflation may be on its way...

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So, what is going on with other commodity (and similar) prices lately?   Below are charts and comments on 10-year treasury interest rate, the Baltic Dry Index (shipping rates of bulk commodities), oil & gasoline, steel and iron ore, copper and silver.  The general trend for all of these is down.

US Treasuries (here, 10-year Note, a three-year chart (note above US$ chart is a six month chart)) typically move with the US$, but the correlation is not all that strong.  Here is what the 10-year rate has been doing (lower rate = higher Treasury price approx. = weaker economic conditions):

Note that interest rates is a complicated topic, even Treasury rates (being about the easiest to analyze of all interest rates) are difficult enough, even for professional traders!  Treasuries and the stock market interact with each other more so than either with commodity prices.  Bottom line here is that lower 10-year rate hints at weakness...

The "Baltic Dry Index" ("BDI") is a aggregation of shipping rates for bulk commodities in ocean-going ships.  Think cement, iron ore, and corn.  A weak BDI suggests weakening economic conditions.  The BDI is down lately, as conditions are weakening in China:

I would characterize shipping rates as additional, but weak, further evidence that things are getting weak, which implies deflation...  Treasury interest rates and the BDI both hint at weakness.

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Energy prices (here we will look at crude oil and gasoline) have been weak lately.  Even retail gasoline has been going down, I have not had to pay $70 to fill my SUV's gas tank in some two months.

Crude oil:

Gasoline (three-year chart):

The above price of gasoline chart is a two-year chart of gasoline prices in BULK.  Note that over the past two weeks that the price is down some 10%.  I will be watching to see if prices at the pump start to decline (at least some).  I have seen reports of some retail prices for regular unleaded at just under $3.00 per gallon!

Oil and gasoline prices are down.

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There are reports out of the Far East (China) that iron ore prices are down.  Iron ore, of course, is the raw material most used in making steel.  Recent iron ore prices:

China is the main world driver of iron ore prices.  China (particularly construction) is slowing, they are using less steel (and so iron ore) as well as cement.  Steel prices are approximately stable, here is a chart of steel rebar (used for reinforcing concrete in construction), note this is a 12-year chart, so it does not clearly show recent price moves in detail.  I should also note that there are LOTS of different kinds of rebar (not to mention steel), so the +/- 15% price decline since perhaps Jan 1, 2012 does not give us much information.  Note that the peak price was in late 2008 (when the financial crisis hit).

Rebar prices fairly well correlate with other forms of steel, see

Two-year copper (used by China in construction, electricity and automotive):

Copper has been relatively weak in 2014 (as well as the past two years).  But, the above copper chart is but weak evidence (but additional) that deflation may be imminent...

Metals prices are down for 2014, and even over the past couple of years.  But, prices are not down dramatically!  I would characterize metals prices as being weakly correlating evidence of current or soon-to-be deflation.

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US produced agricultural commodities are weaker, but each of these have other factors that affect prices (like crop size!).  Corn:


Soybeans, very weak!

Note that all three ag charts show substantial 2014 price weakness.  I would characterize those charts as additional evidence of price weaknesses ("deflation"), at least for 2014.  Note that each of the above charts do not look exactly the same (although corn and soybeans do correlate fairly well).

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US$ strength, declining Treasury rates (2014), declining BDI (2014), lower oil & gasoline prices, lower metals prices and lower US agriculture prices all point, to varying degrees, a deflation.  Note that all of the above are commodities that are heavily traded...

On the other hand, some commodities do NOT point to a deflation.  Coffee (which after crude oil is the world's most heavily traded commodity!):

Coffee is up big in 2014.  Maybe there was a poor harvest somewhere...?  There is very little coffee produced in the USA.

Stocks?  Up, up and away (except for the past two weeks!):

Coffee may be some kind of a special case.  The S&P 500 seems very highly valued (overbought) to me...  Beware buying stocks now...

IMO, the strength of the stock market is perhaps a warning bell!  And coffee may have characteristics that currently do not reflect world economic weakness.

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China is weak.  Europe is weak.  Peru is weak.  The USA is outperforming the world!  Will this continue?  Ahh...

Yet, we hear that QE is happening everywhere (China, Japan, soon in Europe, and probably to continue in the USA particularly if stocks go down, the Fed will ease...).

At some point, IMO, the strong US$ and additional money-printing (in whatever form) will lead to the commodities to start going up.

"Deflation Now, Then Inflation?"


  1. Bob,
    The only commodity going up is deal with all the Carnage in the rest of the market. I don't think the FED has a plan for Deflation...shit, I don't either.
    PS Thanks for the Charts.

  2. I recall reading coffee has gone up due to the Ebola outbreak in West Africa.

  3. Robert, Here is a recent and relevent remark on subject from one who knows more than a little.

    Daily Bell: Please define deflation and disinflation from both a monetary and price standpoint. Antal Fekete: Deflation is clearly not the same as a falling price level. Technological improvements in production cause a gently falling price level under sound money that is no deflation. Defining deflation as a contraction of the stock of money is plainly wrong. We have a vastly expanding money supply, yet a lot of economists (including myself) hold that we are in the midst of deflation. I prefer the definition of deflation as a pathological slowing in the velocity of money .


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