September 23, 2002 – Though every market is different in that each one is driven by its own unique factors affecting supply and demand, there are established relationships between some markets. For example, if the price of grain rises suddenly and unexpectedly, the price of beef often declines. The reason is that the higher price of grain forces farmers to prematurely liquidate their cattle herds, with the result that beef prices decline from this added supply brought suddenly into the market.
Another relationship that has historically proven to be valuable is gold and the CRB Index. The Commodity Research Bureau Index is a very useful measure of a basket of commodity prices. Therefore, trend changes in the CRB itself are an important indicator of overall commodity price trends. Though the components of this index were changed several years ago, weighting it more heavily toward energy and less so toward agriculture, the CRB Index remains a widely followed indicator. And its relationship to gold reveals informative changes about the purchasing power of the US dollar.
The principle underlying this gold/CRB relationship is very simple. Rising commodity prices are a signal that inflationary pressures in the economy are building. If inflationary pressures are building, the purchasing power of the dollar is declining and the gold price should be rising as well.
Right now the CRB Index is giving us a message of rising inflation, which brings me to the accompanying chart. This chart presents the monthly CRB index and gold price from 1982 to August 30th. Note the clear historical pattern on the chart. When the Gold price rises (points A and C), the CRB follows. Then Gold falls (B), and again the CRB follows. Gold therefore leads the change in commodity prices, which is natural and to be expected because gold is very sensitive to inflationary pressures and other forces that impact the purchasing power of the dollar.
In the early-to-mid 1990’s at points D and E, the relationship between gold and the CRB is less clear. I believe that hedging by mining companies and shorting of gold by banks that have borrowed and then sold gold together explain what caused the pattern of the CRB and gold to change. But even with these distortions, the relationship nevertheless remained more or less the same – Gold leads and the CRB index follows. Recently, however, that pattern has changed noticeably.
Compare point G to the previous turning points on this chart. Gold went nowhere, but the CRB rose. Given this result, it is logical to ask whether the historical relationship between gold and the CRB Index ended. It hasn’t, as recent results indicate that the relationship is again more or less back on track.
Gold is money, and it is sensitive to inflationary pressures on the dollar. But Gold didn’t lead the CRB Index higher at point G as experience and logic say it should have done because the gold price is being manipulated.
That observation should not come as any surprise to the readers of these letters. Since 1997 I have been making the case in these letters that the gold price has not been allowed to trade freely to reach its fair value, and the above chart just provides more evidence of this proposition, not only in past years, but also at this very moment.
If gold were trading freely here, its price would be a lot higher, based on its historical pattern which shows that gold leads and the CRB follows. In fact, just by looking at past patterns of gold and the CRB Index on the accompanying chart, one can easily see that gold should now be somewhere above the CRB Index, and therefore somewhere above $350 per ounce, given the recent jump in the CRB.
So this chart provides more evidence of the ongoing manipulation of the gold price. This manipulation is a reality that we have to contend with at present. But it is also a reality that even governments cannot manipulate a market forever, because in the end, markets are bigger and more powerful than governments. And this chart suggests the real possibility that the manipulation of the gold price is ending. Here’s the evidence leading me to this conclusion.
Note that the current pattern more closely resembles the historical patterns, with both the gold price and the CRB Index rising. To be sure, there is a difference today from the historical pattern – namely, the gold price is not leading. Instead, the CRB Index and the gold price are rising together. But here’s the important point. In contrast to the previous cycle, both gold and the CRB Index are rising.
The forces that have been managing the gold price are finding it more and more difficult to keep the gold price from seeking its natural and unfettered price. The force of the market is overpowering the force of government, which has been acting to keep the gold price under control. Thus, look for the gold price to rise further from here, with the rate of increase probably starting to outpace the rate of growth in the CRB Index.
What’s causing the strength in th CRB Index? Will this strength continue? There has been a relatively strong across-the-board rise in commodity prices. Crude oil prices have been rising pretty much all year. We have also seen strength in the grains and recently prices have been rising in what are called the ‘soft’ commodities, such as cocoa and sugar.
Thus, the run-up in the CRB cannot easily be blamed on bad weather. There has been a broad-based rise in the index, which can really mean only one thing – the Dollar is losing purchasing power. The Federal Reserve is allowing a growth in dollars greater than the demand for dollars, with the consequence that the dollar is purchasing less and less. Commodity prices are rising.
I find this message particularly interesting at this moment in time. The CRB Index has in recent years been largely ignored and forgotten because of the conventional (but incorrect) wisdom that there is no inflation. In other words, because a lot of people believe that inflation is not a problem, the CRB is largely being ignored. But those who ignore the message of the CRB Index do so at their peril. Rising commodity prices are back, and I think that rising prices – commodities and gold – are here to stay.