18 April 2009

Commodity outlook bullish on Inflation /1935-1945 record

Puru Saxena makes the case......

Today, there are many deflationists who are claiming that the prices will remain depressed for many years due to the weak economic activity. However, these folks should note that even during the Great Depression of the 1930's, prices of commodities stabilised and began rising in 1933. Figure 1 confirms that due to monetary inflation in the early 1930's, the CRB Index embarked on a secular bull-market which had a violent correction in 1937 (marked by purple arrow). Following that crash, commodities bottomed out in 1938 and thanks to the super-inflationary efforts of President Roosevelt, the CRB Index surged for more than a decade.

Figure 1: CRB Spot Index - (1930-2007)

Source: Commodities Research Bureau

Contrary to popular opinion, that huge commodities boom took place despite an economic depression. Furthermore, it is worth pointing out that commodities rose relentlessly despite the fact that private-sector debt and bank lending remained essentially flat until 1945. Back then, similar to the current situation, banks accumulated large reserves but didn't loan these reserves into the broad economy. However, from 1932 onwards, the US government borrowed so much new money into existence that prices began to rise way before private-sector credit started to expand.

A similar drama unfolded in the 1970's when commodities went through the roof. During that time, economic activity was dismal but governments decided to tackle the recession with money creation. The net result was surging hard asset prices and mind-numbing inflation!

Turning to the present situation, US private-sector debt is shrinking as banks remain fearful of lending. However, the US government (along with other nations) is borrowing and creating gigantic sums of money and this should cause prices to rise for the next 3-4 years. Accordingly, we are maintaining our positions in top-quality businesses in the resources sector.


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