I’ve attached a picture of commodity prices measured by the CRB Index which is in orange and treasury rates on 10-year government treasuries in white.  Notice how they have been correlated going back to the early 1970s.  But in the early part of this decade, they began the decoupling process.  Commodities started racing up and treasury rates have continued to stay low.

Commodities vs. Treasuries

First of all, they have been correlated because when commodities start to rise, interest rates go up as inflation comes into the picture.  Then, high interest rates cause less demand and commodities fall.  So, why have things changed and will they start to be correlated once again?  Yes and no.

There is a logical explanation of what’s goin on here.  Emerging markets are demanding more commodities than the supply.  Therefore, prices have risen.  But, why have rates not gone along with them upward.  This is because as emerging markets have developed and used more commodities, they have placed their capital in U.S. markets through the purchase of U.S. Treasuries.  Why?  Because they know they will get their money back even if it’s earning crappy rates and the dollar’s weakening.  So, more bond purchases mean lower interest rates.

Think of it like a gentleman’s handshake agreement.  We think of it, they manufacture it, we buy it, they use the proceeds to buy our bonds.  This keeps our rates down and keeps us refinancing and buying consumer electronics.  So, we get cheap products and help financing our country and they get prosperity. 

So, will it continue?  That’s the real question.  I believe over the next few years (and perhaps months) as our economy recovers, our long-term interest rates will rise and commodity prices will at least not go up as fast.  But, commodities are in a secular bull market and I don’t think they will be falling by 50-75%.  They will have corrections like they are having now but they are corrections.  In addition, I don’t think interest rates are going to double digits.  So, yes, I think we’ll see this gap tighten but the correlation like we saw in the 1970s, 1980s, & 1990s isn’t coming back anytime soon.


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