MARKET COMMENTARY
No. 4, 22 August 2008
The Long-Term Sustainability of Recent Commodity Price Strength
Commodities prices have been rising for nearly seven
years now. The increases in prices are spread across many
commodities. The CRB commodities index has risen
149% over the past 80 months, through June 2008. That
far exceeds the two earlier major upward moves in com-
modities prices since World War Two. Those two events
had lasted 37 and 40 months, respectively, during the high
-inflation era of the 1970s. After they had ended, com-
modities prices, as measured by the CRB index, entered
into a two-decade long period in which the CRB index
declined 45.5%.
Commodities prices rose into July, and then were hit by a
wave of selling, which pushed prices down to technical
support levels. Most of the selling came from short-term,
technically based long-only fund managers, and was based
on price momentum indications that suggested that prices
would drop in a seasonally inspired fashion, exacerbated
by short-term profit taking and long liquidation.
Following this decline in prices, during early August there
was a wave of commentary that commodities prices per-
haps had peaked, ending this nearly seven year run. The
commentary primarily came from the same short-term,
technically based long-only fund managers, and was based
on the fact that prices had fallen. There were very few
macro-economic or fundamental arguments raised to sup-
port the supposition that prices indeed had reached a long-
term peak.
In fact, there are some macroeconomic and industry-
specific fundamentals that suggest that prices may reach
an interim peak and could in fact spend much of the next
year or two consolidating just below recent peaks. How-
ever, most of these developments suggest a pause, not an
end, to the upward move in prices. There are other, longer
term macroeconomic and fundamental reasons to expect
such a consolidation phase will only be a pause, to be fol-
lowed by continued strength in commodities prices in the
long run of several years.
The macroeconomic factors suggesting a pause in prices
are those that indicate recessionary economic conditions in
North America, Europe, and indeed the world. Recessions
Copyright CPM Group 2008. Not for reproduction or retransmission without written consent of CPM Group. Market Commentary reports are published by CPM Group and are distributed via e-mail. The
views expressed within are solely those of CPM Group. Such information has not been verified, nor does CPM make any representation as to its accuracy or completeness. Any statements non-factual in nature
constitute only current opinions, which are subject to change. While every effort has been made to ensure that the accuracy of the material contained in the reports is correct, CPM Group cannot be held liable
for errors or omissions. CPM Group is not soliciting any action based on it. Information contained here should not be relied on as specific investment or market timing advice. At times the principals and associ-
ates of CPM Group may have long or short positions in some of the markets mentioned here.
end, however. The fundamental factors largely relate to
these recessionary indications. They suggest interim con-
solidation. They do not suggest either a permanent end to
the strong demand, and consequently prices, of the past
seven years. Nor do they suggest a massive decline in
prices such as the 20-year bear market that preceded the
current seven-year bull market.
Furthermore, even as there are signs of economic weak-
ness, there are offsetting signs of strength. While the hous-
ing market in the United States and some other countries
has been gripped with weakened demand and lower prices,
nonresidential construction spending has surged to record
levels in the United States and most of the rest of the
world. Infrastructure spending meanwhile also continues
to grow at strong levels in most parts of the world. Some
superficial analyses suggest that the infrastructure spend-
ing represents special events, such as the Beijing Olym-
pics, and that spending will plunge after that event. That is
nonsense. Construction spending on the Olympics repre-
sented a small portion of capital spending on infrastructure
throughout China.
More important, the amount of money looking for good,
safe, or at least less dangerous or risky investments contin-
ues to grow strongly. Some observers believe that this
represents monetary authorities pumping up money supply
to stave off a recession or worse. Again, this is misplaced
and not based on data. A closer look at the sources of
wealth creation, and transfer, shows that the rise in this
historically large pool of investable funds pre-dates the
current economic slowdown and shift in monetary policy
by years, and has its roots in the real economic expansion
that has been underway around the world since around
2002.
The Basis of the Rise in Commodities Prices
Commodities prices have risen as much as they have since
2001 due to a complex mixture of trends and events. First
and foremost, there has been an upward shift in the fabri-
cation demand curve for most commodities, reflecting

strong long-term real economic growth and expansion
around the world. The rise of emerging industrial coun-
tries has unleashed a surge in demand for all sorts of
goods and services of unprecedented proportions around
the world. This has boosted demand for many commodi-
ties. Even with the current economic slowdown, demand
is still rising strongly on a long-term basis, and remains
very high compared to earlier levels.
There also has been an upward shift in the investment de-
mand curve, as more investors are interested in putting
more money in to commodities than ever before.
These two trends primarily have been responsible for the
increase in commodities prices. Both of these trends are
still very much in place, even allowing for partial reduc-
tions in demand due to temporary, cyclical declines in
overall economic activity. Even as the world is being hit
by recessionary conditions, it must be noted that demand
for many commodities continues to expand. The rate of
expansion in demand is slowing, but it still is increasing.
In other markets, demand in fact is falling, although the
declines in demand are far less than market commentary
suggests.
Supply responses to the rise in prices as a consequence of
the increased fabrication and investment demand have
been slowed, meanwhile. This in part has been due to the
lack of investment in commodities producing industries,
which were impoverished during that earlier 20-year bear
market.
The Future
All of these forces have boosted prices sharply higher.
Now, in 2008, economic growth is slowing in the United
States, and spreading to most other parts of the world. The
economic pain is expected to grow worse between now
and the middle of 2009. Beyond that, there is a good pros-
pect that economic recovery will come fast and strong,
boosting real economic growth once more.
The most likely economic scenario is for the current pe-
riod of recessionary economic conditions to be relatively
short and shallow, as have been the two previous reces-
sions, in 1990 and 2001. These two recessions were
among the shortest and shallowest recessions in history,
and were spread apart by some of the longest periods of
recession-free real growth in at least two centuries. The
volatility of real economic growth has been reduced, both
CPM GROUP
MARKET COMMENTARY NO. 4
in the United States and globally. This reflects better eco-
nomic conditions. It is due to a combination of many fac-
tors, including automation and computerization, which
allow better planning on the part of governments, indus-
trial concerns, and investors. It also reflects the benefits of
financial and economic deregulation around the world,
from the United States starting in the late 1970s to China
in the past decade. It reflects the internationalization of
labor, the rise of lower cost, more efficient international
shipping, financial market deregulation, the rise of non-
bank debt financing, and many other trends. It may seem
heretical to some of the more demagogic market commen-
tators, but the stronger, less volatile economic growth pat-
terns of the past quarter century also reflects better mone-
tary policy management since the early 1980s.
Real Gross Domestic Product
Annual, Projected Through 2018
% Change % Change
9 9
World
8
Emerging Economies
8
7
Advanced Economies
7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08p10p12p14p16p18p
Economic conditions suggest that the current period of
weakness in the U.S. and global economies is likely to be
relatively short and shallow as well. None of the trends
that have contributed to the reduction in economic volatil-
ity and stronger, more durable overall economic growth
have been reversed or reduced. If anything, these trends
are self-reinforcing, as economic theory suggests they
would be, so that the impulse toward stronger growth and
greater consumption is likely to gain strength rather than
lose momentum in the long run.
In this environment, the current slow down in demand for
commodities, and the recent short-term spike down in
prices, should be seen as interruptions to a longer term,
multi-year upward trend.
It Could Go Wrong
The earlier discussion discussed the fact that economic
2

conditions and trends over the past 25 years have been less
volatile than at any time since at least 1800. This is true,
and overall this more stable economic growth continues.
Within the context of such reduced volatility, however,
things have worsened over the past few years. While eco-
nomic conditions remain relatively stable compared to pre
-1983 patterns, at present economic trends have become
more volatile, and the predictability of future courses of
economic trends has become less certain. than they had
been since 1982. This volatility in economic trends is be-
ing reflected in increased financial market volatility, and
in commodities prices.
The most likely scenario for future economic trends re-
flects a continuation of the trends and conditions over the
past quarter century. The alternative scenarios would have
a much more severe recession, complicated and com-
pounded by the structural weaknesses in the international
economy, including the massive U.S. budget and trade
deficits, and the enormous amount of debt that has built up
in the U.S. economy. Furthermore, the probability that one
might assess such a more destructive alternative scenario
is higher than it would have been at any point since 1982.
The reason such a more severe recession seems unlikely is
that these structural problems are manageable, and are
offset by other factors that suggest the the current reces-
sionary period will be contained and will be followed by
stronger real economic growth. However, there are forces
abroad in the economic and political spheres that could
upset this scenario and reverse the past quarter century‟s
progress toward more stable and consistent economic
growth around the world.
Should a more hostile economic environment develop, it
would follow that demand for many commodities would
decline more sharply than is anticipated in the most likely
economic scenario. this would lead to a period of lower
prices for commodities.
Whether or not gold prices would decline in such a sce-
nario is more a matter of uncertainty, and would depend
on the nature of such a cutback. If a sharp reduction in
economic activity led to a rise in U.S. interest rates simul-
taneously with a shift in investor attitudes toward a more
positive view of the U.S. economy‟s relative expected
economic strength, then the dollar could rise and investors
would shift from using gold as a safe haven to using the
dollar. A similar pattern was seen in the 1980 – 1982 dou-
ble-dip recession. However, that might not be the case,
CPM GROUP
MARKET COMMENTARY NO. 4
the next time around. In 1980 – 1982 many of the finan-
cial tools available today for investors to hedge against
economic problems did not exist. More important, in 1980
– 1982 the dollar was seen as being in the early stages of a
protracted upward price trend, and interest rates available
on U.S. Treasury bonds and bills were well over 10%. The
dollar was the king of safe havens at that time. Gold fell
from its $850 peak in January 1980 to a low of $298 in the
middle of 1982.
At present, the dollar is in the eighth year of a major
downward move. While some investors think the dollar
could recover on a short or medium-term basis, the market
consensus is that the longer term outlook for the dollar is
negative. Also, U.S. interest rates are at extremely low
levels, and are negative when adjusted for inflation. In this
environment, the dollar hardly presents any competition
against gold as a safe haven. Depending on how a more
severe economic downturn developed and proceeded, it is
quite possible that gold would still be viewed as the supe-
rior safe haven, as investors have seen it to be from 2002
into 2008.
Regardless of how gold and other commodities performed
in such a worse-case economic scenario, it would be ex-
pected that even such a worse economic downturn would
prove to be a temporary setback to the world economy,
and commodities markets. Recessions do end. In fact,
every recession that ever has hit the world economy has
ended. Some are long and painful. Some turn in to depres-
sions, or are related with other economic and political
events that ultimately lead to war. But, they do end. When
the current economic slowdown ends, whether it is in the
last half of 2009 or sometime later after a more difficult
recession, the longer term economic trends and individual
market fundamentals probably will point to strong demand
and higher prices.
Longer Longer Term
This article has concentrated on the long-term trends in
commodities prices, suggesting that the recent strength in
commodities prices should be expected to continue. It has
granted that there could be weakness in commodities
prices over the next two years, due to slower real growth
in many parts of the world. In our most likely scenario,
that weakness in commodities prices would be represented
by prices consolidating at historically high nominal price
levels. In a darker alternate economic scenario, prices fall
further over the next few years, but later return to their
3
 CPM GROUP
MARKET COMMENTARY NO. 4

upward trajectory, as the world economy dusts itself off can be seen in the chart earlier in this report, that since
and returns to the stronger growth patterns of the past two World War Two the only two upward moves in commodi-
decades. ties prices lasted less than three and a half years, or 12
years if you think of them as two legs of a broader upward
Two provisos ought to be addressed about even longer move. To find longer term upward legs in commodities
term issues. prices, one must look at prices back to 1800. There, one
finds longer running upward moves, related to the revolu-
First, and most important, is the fact that long-term real tions that wracked Europe and the U.S. Civil War in the
economic growth generally has been associated with a 1850s and 1860s, the First World War, and the Second
long-term decline in real, inflation-adjusted commodities World War. In other words, to justify the concept that we
prices. That does not mean that nominal prices have fallen, are in the early stages of a supercycle, one almost needs to
but that the purchasing power equivalence of most com- believe that the world is on the threshold of World War
modities has dropped. This has reflected technological Three. The marketing groups behind the supercycle theory
improvements in the discovery, beneficiation, and use of have responded by saying that perhaps the world is headed
most raw materials due to industrialization. Such a long- toward a third world war, overlooking the further analysis
term pattern of declining real prices may be expected to that any future world conflagration most likely would not
continue in the very long run. In the shorter long run, if be fought like the previous shooting wars, and thus would
you will – a period of five to 10 years – real commodities have a radically different implication for basic commodi-
prices may continue to show strength, reflecting the ongo- ties.
ing problems in increasing supply to meet rising demand.
Longer term, that rise in real prices might end. The entire discussion of a supercycle is a senseless distrac-
tion from the realities of the commodities markets, how-
Commodity Prices since 1957
Index Index ever. The upward trend in commodities prices since 2001
500 500
can be explained best based on simple fundamental eco-
450 450
nomic trends: Strong fabrication demand, strong invest-
400 ▲ 149%
▲ 277 pts
400
ment demand, and lagged supply responses as a result of
350
▲ 78%
80 Months 350
years of under-investment in commodities producing in-
300 ▲ 147 pts
40 Months Nominal CRB Index
300 dustries. Within such a straightforward economic analysis
250 250 of the roots of recent commodities prices lies the answer
200
▲ 134%
200 to whether recent price strength is sustainable. As long as
150 ▲ 130 pts
37 Months
▲ 237%
▲ 235 pts
150 these underlying trends remain in place, and allowing for
100
112 Months
100 cyclicality in economic and market conditions, one should
50
Real CRB Index
50 expect commodities prices to do well in the years ahead.
0 0
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

Second, and far less important, relates to the ongoing su-

perficial reliance of marketing gimmicks to explain finan-
cial market trends. Over the past several years many in-
vestors have been attracted to the commodities market
with marketing hype related to a „commodities supercy-
cle.‟ This unscientific theory suggests that commodities
prices rise strongly for 17 years in broad upward cycles. It
has all of the statistical underpinnings of the “New Eco- Note: This report is a pre-print of an article to be pub-
nomic Paradigm,” the marketing pitch used by financial lished in the September issue of Commodities Now maga-
advisors in the late 1990s that suggested that there never zine. The final article will vary slightly from the early
would be a period of recessionary economic conditions, manuscript here. CPM Group clients are invited to read
high inflation, or declining stock market values ever again. the final article, along with numerous other interesting
CPM Group has written about the lack of substance be- and valuable articles, online at www.commodities-
hind the supercycle marketing pitch. It has pointed out, as now.com.