An Update To The Commodity/Interest Rate Picture

For the past few years, I’ve monitored the correlation between commodities and interest rates measured by 10-year treasuries.  In fact, I’ve published this picture many times on this blog.  Going back, there had been a very tight correlation up until around the beginning of this decade.  Then, it all changed.

commodities vs int rates 5 22 09


The picture above is a graph going back to 1973 of interest rates in red vs. commodities in blue.  The correlation broke in early 2002.  This is easily explained because the emerging markets (especially China) began prospering and moving their new wealth into our bonds pushing down our rates.  In turn, Americans had low interest rates for the whole decade to purchase many things on credit, especially goods produced in China.  China got richer because of it and the circle was complete.  Commodity prices rose as the emerging markets continued to prosper and rates stayed low.  Everyone was happy.

The above situation seemed like it could go on forever.  But, I continued to show this graph in speeches telling the audience that generally when you have a correlation this tight that temporarily breaks apart, just give it time and it will come back together.  We knew at some point the red line (interest rates) would go up and/or the blue line (commodities) would come down.  What we didn’t know is how quickly that gap would close. Well, it closed in a matter of just a few months.  A painful drop for those long commodities and the companies in those businesses.

You can see from the updated chart above while still a gap, we’re more in a normal range.  I suspect going forward with the constant printing of U.S. dollars that interest rates will continue to rise.  In addition, commodity prices will continue to rise as well.  So, don’t look for the gap to re-appear but simply both lines to move up over the next few years.

That means shorting U.S. treasuries and going long commodities.  I would love if that was a buy and hold strategy but the easier trade of the gap closing is in the past.  Now, it’s about other factors.  You’ll have to trade around those positions but shorting treasuries and going long commodities is a nice longer term trade.

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2 Responses to “An Update To The Commodity/Interest Rate Picture”

  1. 1 tom June 1, 2009 at 11:56 am

    Karl, at what point does the increase in commodities become a drag on the economy? We are seeing commodities rise pretty rapidly and we are seeing interest rates jump pretty quick. Aren’t both of these going to be a big drag on the economy at some point. Thanks

    • 2 keggerss June 1, 2009 at 11:58 am

      Excellent question and point. At some point, you’re correct. However, right now we’re not seeing any signs of that happening just yet. The economy continues to improve. It’s always hard to say which comes first, the cart or the horse. Right now, we’re betting on an improving economy.

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