Guambat Stew: "Oils ain't oils"

I reckon that's a phrase from some old Australian advertisement. It's

used frequently Down Here (just google it to see) with the connotation of "don't mix your apples with your oranges" mixed with "what you see isn't always what you get", and with a dash of the "parts, what parts" question. But that's not what this post is about.

Barry Ritholtz, the first blogger I read every day, and my second most favourite blogger after yours truly, puts up some very interesting charts, one offered by leading mining company BHP Billition, showing the nearly 2 century decline in commodity prices, and asks the somewhat cheeky question, "Are Real Commodity Prices at multi-century Lows?" at this post:http://bigpicture.typepad.com/comments/2005/09/are_real_commod.html. (I won't put them up here, so please have a squidge of them there to better understand what follows.)

Since I've been expressing my agro at the way the dot.commodity boom has been distorting the Oz market broader index (http://guambatstew.blogspot.com/2005/08/dotcommodity-boom.html), these charts and that question have really unsettled me.

First of all, that cheeky little question, are commodities at their low? When you suggest something that we think of as cyclical (e.g. this CRB chart http://www.chartingyourfutures.com/historic.htm)

is at a low, you anticipate it will reverse higher. But Barry is way too bright to say so. Indeed, his question is merely are they at multi-century lows, and it is I who infers the anticipation of reversal, and that's what makes his question so cheeky. Well, h*ll yes, anyone can look at the charts and see they are indeed at multi-century lows, or nearly so, but that alone shouldn't be taken as an implication that things are any time soon about to change the multi-century trend in lower and lower commodity prices that the charts reveal.

Moreover, stop to look at the links he adds to the words 'real' and 'commodity' and 'prices' in the quote: "...we find ourselves at a period of time which is, or rather close to it anyway, 2001/2002 when real commodity prices were the lowest they’ve been in the last 200 years ...." This is really where he gets cheeky, because the links do not support any implication of reversal.

The 'real' link leads to an article referring to the mulitfarious factors impacting on commondity prices, highlighting interest rates as a prime factor, and concluding "...the Fed's continued action to increase short-term interest rates this year and move them back towards a neutral setting could eventually dampen real commodity prices. In other words, it is not just real estate, junk bonds and emerging market debt that are vulnerable. Commodities are, too. "

The 'commodity' link leads to a study examining commodity prices over the period 1862-1999 as determined by The Economist's index of industrial commodity prices, and concludes, as stated in the abstract, "First, while there has been a downward trend in real commodity prices of about 1 percent per year over the last 140 years, little support is found for a break in the long-run trend decline in commodity prices."

Finally, oils ain't oils. BHP produced the chart, one would surmise, to suggest that there is a liklihood that commodities have bottomed, and that would have positive ramifications for its stock price, since it is a major producer of coal, iron ore, copper, oil and other minerals and metals. There may be evidence that such "hard" commodities have indeed bottomed. But I am not sure that you can tell that from the proferred charts. Just as I've reminded those who would buy the whole Oz market index to get exposure to the materials sector that they are buying 75% "junk" (non-materials and energy sectors), the whole commodity universe that is reflected in the charts consists of soft and agricultural products as well as base metals and minerals (see the Appendix to the study at the 'commodity' link), so if you are buying BHP based on the charts of the broad commodity index, you could find yourself way off beta.