A rapid devaluation of the U.S. dollar since early March has fueled a significant rally in commodity prices, prompting investors to wonder if some of the current gains are sustainable.
Since the stock market recovered from a twelve and a half year low reached on March 9, the Thomson Reuters Jefferies CRB Index, a benchmark of 19 commodity futures contracts, has advanced 33%. Commodities such as copper, sugar and crude oil have posted gains north of 69% since the market rally began (see table on page 2).
Commodities, which are priced in U.S. dollars, have an inverse relation with the value of the greenback. While commodities have risen, the U.S. dollar has consistently depreciated across the board in the past eight months, down 15% versus a basket of 6-major currencies, as market participants seek investments in higher yielding currencies.
The sharp increase in commodities is mostly attributed to the weakness on the U.S. dollar, which is seen as a safe-haven investment in times of uncertainty, but loses ground as risk aversion diminishes. Indeed, a regression analysis on the price of the U.S. dollar and the RJ CRB Index dating back to July 2008, shows an inverse correlation with a correlation coefficient of -0.74 and an R-squared of .55.
Along with an uptrend in most commodity prices, the currency value of export-driven economies such as Australia, Canada and New Zealand has gone through the roof. Consider Australia, for example, a leading exporter of minerals and metals, which has seen its currency appreciate 40% against the greenback since early March.
Following the sharp moves experienced in some of these commodities and currencies, some analysts on Wall Street remain cautious about further advances, accounting for a market pullback. Earlier this week, Dennis Gartman, founder and author of the The Gartman Letter said, "We are getting a solid correction in commodity prices... too many people got on one side of the boat, pushing the dollar far too low."
Although the price of commodities has significantly fluctuated over the past years, it was not until mid-2007 and and mid-2008, when these moves were accentuated, leading some investors to argue that prices may be getting back to previous levels. As shown on the graph below, the ratio of commodities index to the dollar index is now close to the period from July 2005 to mid-2007.