Commodity Conundrum

by David Petch


The following article was presented on Saturday, December 15th, 2007 for the benefit of subscribers.

Inflationary cycles are always manifested towards the end with rises in commodity prices that become equivalent to a black hole where money gravitates. Increasing the supply of money is the very definition of inflation, with rising prices being a symptom. Interest rate cycles tend to last 20-30 years starting from a decline to a base, followed by peak. Central banks use interest rates as the brakes of an economy and is the primary tool used under fiat currencies. Central Banks could stop printing money, but that would lead to a deflationary collapse, which is not a desirable outcome...so inflation it is. After interest rates rise to cool things on a Cycle Degree, periods of declining interest rates occur which will often see a decline in prices. Money is still being printed in the background, so the general overall theme is inflation, albeit maybe 1-2% instead of 15-20% near the end of the cycle. As economies begin growing with lower interest rates a credit economy emerges where companies and people essentially leverage their ability to purchase goods and pay it back later (a totally different concept than "Pay if Forward").

Towards the end of the credit cycle, inflation begins to grow due to expansion of the money supply and credit (due in part to the fractional reserve system used by banks). Rising interest rates eventually makes borrowing expensive, thereby quashing demand for things and causes scaling back in consumption sectors of the economy. During this phase, there is an increase in the amount of money circling the globe to try and find somewhere to park into something "tangible". Gold and silver and are often viewed as "tangible" items once the economy shifts from a credit economy to a "necessity economy" (paying only for the essentials such as heat, food, fuel for transportation etc.).

Supply and demand dynamics generally see commodity prices rise during the terminal portions of inflation cycles and decline during subsequent periods of disinflation. Once disinflation kicks in, commodity prices historically decline to near or below operational costs, which cause many companies to collapse. Once demand begins to outstrip supply, commodity prices begin to turn around.


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