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Minyan Mailbag: The Equal-Weighted CRB


How does an index weighting energy at nearly 40 percent accurately reflect what "commodities" as a whole are doing?


Prof. Lewis-

Lance, I am pretty much a commodities bull for the long haul and even more bullish on gold, but I simply have to take exception with your portrayal of the equal weighted CRB as any sort of measure of inflation.
See my CRB chart here.

To start with, I am in the group along with a few Minyanville professors that believe inflation is about an expansion of money and credit, not about rising prices. Also in that group are Marc Faber, Trichet, Saville, Paul Kasriel and other notables. Carol Baum at Bloomberg also seems to be saying something similar recently and I will probably write about that this weekend in my blog. On the basis of a white hot M3, one can say (at least I can) there is "inflation." Since this is a "religious" issue however, and since those who are convinced that inflation is about prices are unlikely to be persuaded, I will move along with my second point of contention with an equal weighted CRB.

Let me ask you a question: What would your response be if the government decided that Twinkies held the same weight in the CPI as housing? I think you would scream. In my mind that is exactly what you are doing when you point out the significance of an "equal weighted CRB." You are essentially suggesting that pork bellies and cotton are as important as gasoline, crude, and natural gas.

The CRB is weighted for a reason. So is the CPI. Now you and I might not like the weightings in the CPI but at least Twinkies are not given the same weight as gasoline. The valid comparison on the CRB should be based on some sort of reasonably weighted percentages. I for one do not agree with the lowering of energy in the CRB. This issue has been widely talked about so I will leave it at that. But what has not been talked about is how much that affected the charts. The only valid comparison on the CRB would be if the makeup did not change over time or at least when it did change, that it was reflected back in time. Correct me if I am wrong, but I do not think that is being done. So when discussing the CRB I would like to see a historic chart that adequately reflects reasonable percentages based on the importance of the commodity in the global economy, that is also not distorted by periodic changes in weightings. Does such a chart exist? If the CRB does reflect those changes then the chart we should be watching is the one that follows, not the equal weighted one that you are showing.

Minyan Mish

Minyan Mish-

I am sorry that you take exception to my portrayal of the equal-weighted CRB as any sort of measure of inflation (although I should add that I am no fan of Twinkies either, that stuff will kill you...). But I digress.

Like those in your group, I agree that inflation is always a monetary event (in my humble opinion anyway), but there are different types of inflation that can result, which affects how it is perceived by the marketplace. For example, in the late 1990s, we had a tremendous asset inflation in the stock market, which most everybody (outside of a few like myself that saw it as dangerous) saw as a positive thing. Traditionally, when people talk about "inflation," they are referring to consumer price inflation ( or "bad inflation"). That's the inflation that central banks (and most people for that matter) don't like, because unlike asset inflation, it lowers the standard of living of those who consume goods and services (which is obviously the public and the great majority of voters, which is who matters in any democratic society).

The CRB is made up of basic commodities that go into just about everything, chief among those being energy. If those prices keep rising, eventually the price increases will feed through to consumer prices, just as a weak currency is generally inflationary by definition as well (ask any South American country). Even the government's own flawed measure of consumer price inflation, which is engineered to show as little inflation as possible, is showing signs of inflation. The year-over-year core CPI rate has begun to climb back over its 200-month moving average for the first time since the great inflation of the mid and late 1970s (see the chart below) .

I agree that energy is more important than pork bellies or silver or whatever (it's clearly bigger in dollar terms as well because of its importance), but why does one look at an index?

Typically, it's because you want to get a gauge of how a broad basket of something is trading (are most components going up or going down, in very simple terms).

If one is trying to determine whether a bull market (or upward trend) in "commodities" is still in place or not and therefore whether consumer price inflation is still in an upward trend or not (assuming we agree that commodity inflation generally feeds into consumer-price inflation at some point), then I don't think one can just look at energy (especially when so many other commodities like sugar, corn, etc are being harvested now for energy as well). This is because energy (like everything else) can have big corrections from time to time. See the chart below and the big drop in the heavy energy-weighted Goldman Sachs Commodity Index (GSCI) back in 2003. Was that a peak in commodities or "inflation?" Clearly not.

Take another example: ExxonMobil (XOM) has the largest market cap in the US stock market (last I checked). If I made up a stock index of XOM and weighted it at 40 percent and then pitched in another 10 stocks representing the remaining 60 percent of the index, would that index accurately reflect the "general health of the US stock market?" Of course not. So, how does an index weighting energy at nearly 40 percent accurately reflect what "commodities" as a whole are doing? The reason I prefer to look at the equal-weighted CRB rather than the energy-weighted CRB is for the same reason that people prefer to look at the Wilshire5000 instead of the Dow or any other very narrow index in order to determine what the broader stock market is doing. The equal-weighted CRB similarly tells you what a broad basket of commodities is doing.

To make matters worse, the new CRB (CRY) was changed on June 20, 2005 to reflect the higher energy weighting, but the data prior to that was not altered. So, you essentially have two completely different charts that are simply spliced together when one looks at the CRY (I talked about this here back in October of 2006 in case you missed it). Many looking at the crack in the CRY back in the fall of 2006 erroneously concluded that the "trendline break" on the chart meant the commodity bull was dead, even though that trendline was completely meaningless due to the data never having been updated prior to the CRB's changeover in June 2005. The only "CRB" with a history (and therefore "usable"), is the "old CRB" or CCI. If one wants to look at an energy-weighted commodity index, I prefer the GSCI, since it has a history. Because the CRY is "bad data," it's completely useless unless one is only interested in the data since June 2005.

In fact, if you compare the GSCI to the CCI, which I did back in January in the chart below (see my Jan 5th buzz), you will see that any decline in the energy-heavy GSCI that is not confirmed by a similar decline in the CCI is merely a correction and doesn't stick. Since the decline in the fall, the GSCI is once again recovering and moving higher as the CCI makes new highs. Also note that the same can be said for big energy-related spikes in the GSCI (like in 1990/1991 when Iraq invaded Kuwait) that aren't confirmed by a move up in the broad commodity complex (as measured by the CCI). If the CCI doesn't confirm the spike in the GSCI with a move of its own, the spike doesn't stick. Thus, I think this reasonably proves that the CCI is a much better indicator of what "commodities" are doing than any index that is heavily weighted to energy, which is also the case of any broad stock index rather than "just General Electric (GE) or XOM."

Anyway...that's all just my humble opinion of course. Hope that helps.


Position in gold

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