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Why Stocks Will Annihilate Commodities


Was there any time where the upside in commodities was greater than the upside for stocks? No, not even remotely close.


In study after study of commodity valuation, the results are unambiguous and point to one direction. Commodities are likely to offer poor returns over the coming decades. This article adds yet another piece of evidence which strengthens this hypothesis.

For this exercise we use Foundation of Cycles data. When performing a regression of stocks to commodities since 1695 there have been 27 years in which commodities have been this far extended from their predicted value on a percentage basis. That puts commodities in the 91.82% percentile with respect to being overvalued relative to stocks.

Now many of the indicators mentioned in previous articles are at the 98% or 99% percentile. So on the surface this indicator does not seem to be as impressive as others. However, before dismissing this as "not overbought enough," let's first see what has happened when commodities are this highly valued.

For perspective, the most commodities were overvalued relative to stocks by this indicator (i.e. 100th percentile) was in 1980. This would prove to be the peak in the commodity/stock ratio from 1980 to present day. Over the next 19 years stocks outperformed commodities by 1,584%.

By this indicator, during the last quarter millennium the most undervalued commodities have been was in 1999. Over the next dozen years, commodities have outperformed stocks by a respectable 236%.

Before we go further, let's go over some lingo. The "best case" scenario for stocks refers to the outperformance one would have enjoyed by buying when the indicator was at least this overbought and selling when the commodity/stock ratio was at its subsequent all-time low. The "best case" scenario for commodities is the outperformance one would have received by buying when one of the 27 signals went off and selling them when the ratio was at its subsequent all-time high.

Of the 27 times the Foundation of Cycles indicator reached this extreme level, 17 times marked the all-time high in the ratio from that year to present day. Five times the best case outperformance of commodities relative to stocks was in the single digits. Four times the outperformance of commodities relative to stocks was between 10% and 25%. Only once was it more than 25%. This 59% outperformance lasted for all of one year.

On the other hand, if you would have bought stocks any one of the 27 years the indicator was this extended and held until the ratio hit its all-time low, stocks outperformed commodities by at least 381% every time. The average outperformance of stocks over commodities from when the indicator reached the current level to the subsequent low in the ratio was a remarkable 1,727%!

What was the average "best case" scenario for commodity outperformance -- if you bought commodities when the indicator at the current level or higher and sold them when the commodities/stocks ratio hit its all time subsequent high? The answer was 6%.

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No positions in stocks mentioned.
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