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"Always analyze a security in conjunction with others in its relative market."
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Monday, 04 February 2008 |
Why Will Commodity Prices Rise
The theme of classical economics is that there is currently, and always will be, a scarcity of resources - so how each individual allocates his share will give us understanding in a scarce world.
Combining a scarce world of finite resources with a declining dollar, which troubles ones buying power, adds a new dimension to scarcity since it is not that a resource runs out, but rather that one just cannot afford it.
Keeping an Eye on Bond Prices
The inverse relationship of the U.S. Dollar with Bond prices gives a deep meaning and another way of looking at the market as a whole. When bond prices go up, we know that the Dollar is falling. This happens because investors seek safer investments in murky times.
With this knowledge, we now know that when bond prices rise, so will Gold, Oil, Feeder Cattle, Canadian Dollar, Cotton, etc. Most agricultural commodities in general will inflate. And competing interest rates will rise like the Eurodollar.
So as long as the Fed keeps band aiding the current state of the economy by cutting rates, bond prices will continue to soar as well as commodities.
Why Will Commodities Prices Rise When Rates Fall?
As we said earlier, when the dollar declines due to interest rate cuts, bond prices rise because investors seek safer investments (less risky). Commodities hold an intrinsic value - meaning, Gold will always be worth something no matter what happens to the economy, because it is a scarce resource. In Barter systems, Gold was an extreme measure of trade. And until Nixon removed the U.S. off of the Gold standard in the early 70s, our monetary system was backed by Gold.
Fiat money (something that holds no value), like a piece of paper that represents one dollar, really is nothing more than a symbolic means of exchange. In other words, if the U.S. Dollar completely collapsed, paper money will be worth absolutely nothing, no matter how much the bill is worth. However, Gold, Corn, Oil, Cattle, Lumber, etc. will all be worth something because they hold an intrinsic value and a weight in an exchange process.
Determining Future Commodity Prices
To determine if Commodity prices will rise, examine future derivatives for U.S. Treasury Notes. This means to look at call and put options for bond futures. If a call is at a premium, it means that the future price is more expensive then the current price. This means that smart investors are concerned with the future outlook of the U.S. Dollar and are buying Bond Call Options to hedge against falling rates. If we know this is the case, expect to buy derivatives for commodities that run in a direct relationship with Bond prices.
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