Remember all the headlines screaming that the world was running short on oil, corn, wheat, soybeans, etc., causing prices to rise?  I explained repeatedly that what was happening to commodities prices had next to nothing to do with supply and demand for commodities and almost everything to do with the metric (i.e., the dollar) being used to account for them.

Now it seems we are flush with commodities like corn and wheat, which explains the recent plunge in prices.  Or at least that’s what a Bloomberg report claims:

Corn plunged the most allowed by the Chicago Board of Trade, and wheat and soybeans fell, after the government said U.S. stockpiles will be bigger than analysts expected, easing concern about tight supplies of food and fuel.

The oil markets are analyzed in much the same manner in a separate report, also from Bloomberg:

Oil slid 3.9 percent to $99.82 a barrel in New York, extending declines after the U.S. Energy Department said stockpiles rose 3.78 million barrels. Gasoline futures sank 6.8 percent to $3.1507 a gallon after unexpected growth in inventories and amid speculation prices rose too high without confirmation that flooding on the Mississippi River will cut supplies.

I guessed that the crash in commodities would come in mid-2012.  My timing might be off, if what we are seeing now is indicative of a broader undercurrent of money flowing out of the commodities markets.  Or this may be only a waypoint on the way further up.  Only time will tell.  Predictions are easy, so long as they aren’t time specific, but they’re only valuable for traders when they are time-specific.  I’m not a trader, so my focus is not on when something might happen, but whether it will.  And I’m very confident that commodities will crash in the near (<2 yrs or so) future.

Commodities, particularly agricultural commodities, were destined to crash as soon as it was realized there were no real shortages–most of the so-called shortages were due to the hoarding effects of inflationary price increases.  But there is a more ominous possibility as well.  If commodities are crashing because the dollar is gaining value, it must be the result of either fewer dollars chasing more goods (i.e., deflation) or a reduced velocity in the existing stock dollars.  There is no reason to believe fewer dollars are chasing more goods, except that contrived shortages of agricultural commodities may have evaporated (i.e., effectively increasing supply) due to the gathering realization that increased demand was an inflation-induced illusion.   The Fed is still pumping out liquidity to keep real rates below zero.  The real question is whether monetary velocity is declining, which effectively reduces monetary supply the same as Fed tightening would.  It might be helpful to revisit the velocity graph, from FRED:

Graph: Velocity of M2 Money Stock

Latest Observations:

Date 2010:Q1 2010:Q2 2010:Q3 2010:Q4 2011:Q1
Value 1.698 1.702 1.702 1.693 1.690

Velocity is in fact slightly declining.  It bottomed out, as is usually the case, at the end of the last recession, and began climbing, but now seems to have hit a peak of about 1.7 in mid-2010 and is now declining again.  If the commodity price decline is the result of declining monetary velocity, it may very well be that we are entering the next leg down in aggregate economic performance, as people begin hoarding dollars instead of corn and soybeans, just as they did during the most recent recession.  The correlation between commodities prices, monetary velocity and economic performance mostly fails except during periods of economic contraction, when prices and velocity generally decline or remain stable together as the economy contracts.  Comparing the following graph of producer commodities prices with the graph of monetary velocity (above), taking note of the periods of contraction, reveals that it was only in the mid-70’s recession that velocity and producer prices didn’t decline (or in two instances with prices, remain stable) in lockstep with the economy.

Graph: Producer Price Index: All Commodities

My guess?  This is not the beginning of the next leg down.  This mini-crash in commodities prices is closely correlated to a short-term bump in the value of the dollar internationally, which is in turn related to two events tending to firm up the dollar’s value.  First is the recent success at hunting down and killing Bin Laden.  The dollar’s value is inextricably linked to the perceived strength of the American military backing it.  It’s no accident that humiliation in Vietnam was followed by a dollar devaluation that ultimately yielded a dollar crisis in the late seventies and early eighties.  Second is the anticipated end of the Fed’s maniacal money-printing.   Both effects should be short-lived, and commodities prices should begin rising again in short order, especially when it is realized that the political environment makes resolving the US fiscal crisis all but impossible.  Even though commodities prices and money velocity have been lately moving together and down, I don’t believe it portends the beginnings of the next recession.  I still believe that to be about a year away.

But always and forever remember:  When internationally-traded commodities, particularly agriculture commodities, drastically change price, supply and demand fluctuations rarely are the answer to the question of why.

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