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The CRB and the Ten Year



This graph illustrates most starkly the strange environment we are in. An environment that some of us have called "artificial" for it belies economic reality.

The CRB index basically tracks commodity prices and is one component of the PPI and the CPI. Companies incur the cost of commodities and then normally pass those costs on to consumers; this normally creates a strong positive correlation between the CRB and the CPI and PPI. As the government has reported ever more sanguine inflation numbers, this long term correlation has completely broken down.

The difference between the CRB index and the CPI (or even the PPI) is manufacturing costs. If the CRB is going up and the CPI is not this has to mean that either manufacturing costs are going down through gains in productivity or the manufacturer's margins are declining.
But nowadays China and Japan are the main manufacturers, so we are not really sure where the "slack" is coming from (I personally doubt that it is from productivity unless you call paying slave wages "productivity"). We know that U.S. based companies are feeling the pinch. Great Lakes Chemical (GLK:NYSE), a large specialty chemicals company based in Indianapolis, just announced major price increases sighting, "continued hyperinflation on all fronts."

Now we extend the discussion to interest rates. Normally when commodity prices rise it signals a strengthening economy and higher rates. The wide divergence in the above chart is no small anomaly; it is a major chasm that indicates something very different is going on. It is obvious from world-wide capital flows that China and Japan are facilitating the extension from lower margins in manufacturing to "artificially" low interest rates in the U.S., their primary consumer. This completes the circle: lower margins offset by higher volume facilitated by lower consumption costs. Perhaps rather than "circle" the appropriate word is "spiral". The by-product is ever increasing debt.

My contention has been that this cannot last; something has to give. Either rates must rise substantially or commodity prices must fall.

You may have a completely different interpretation of the above chart. If you are bullish on equities by definition you do. But grant me one thing: the above chart shows a complete divergence from the economic reality that we have known for at least twenty years. From there you must clearly think through the possibilities.

If you do, one thing stands out: the probability that this situation continues is very low.

No positions in stocks mentioned.

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