Feb. 4 — The California State Teachers’ Retirement System, the second-biggest U.S. public pension, is considering investments in commodities to boost returns and provide a hedge against inflation and slumping equities.
Obviously the news snippet included above was from last month and, to be fair, pension funds have been hard at work allocating funds towards the purchase of commodities since at last 2004 but... we thought that this might be an appropriate way to lead off today’s topic.
Below we show the ratio between the S&P 500 Index and the CRB Index from 1980 to the present day. Equities rather clearly outpaced raw materials prices from 1980 into 2000 while commodities took their turn in the investment sun over the past decade.
Our thought is that this is either the perfect time to be buying commodities or, perhaps, the worst time. In a sense we are returning to our recent argument with respect to ‘gold versus the banks’.
On a logarithmically scaled chart the ratio of equities to commodities has climbed back up to the resistance line that has defined the ‘strong commodity’ trend since the start of the new millennium. The last time the ratio touched resistance was 2007 which, of course, marked the start of the banking system implosion.
Next is a chart comparison between the SPX/CRB Index ratio and the ratio between gold prices and the SPX.
In 2007 the ratio between gold and the SPX ranged between .4 and .5. In other words if the SPX was around 1000 the price of gold would have been close to 400- 500. At present the ratio appears to be settling into a trading range between .9 and .10 suggesting that an 1150 SPX can support current gold prices.
The key issue is what happens next with the SPX/CRB Index ratio. If it withers and dies once again then gold prices would obviously benefit into 2011. If, on the other hand, the ratio continues to rise towards 5:1- the peak levels last seen in 2007- then gold prices should weaken at least on a relative basis. If, at some point in the future, the ratio moves above 5:1 then the reason to be long both commodities in general and gold in particular has faded away.
Equity/Bond Markets
Below we return to the comparison between the SPX/CRB Index ratio and the share price of GlaxoSmithKline.
Strong commodity prices have only been one half of the story. The other half includes ten or more years of slogging by a whole host of large cap non-commodity stocks. From General Electric to Intel and from Coke to Glaxo the attraction of commodities as an investment class grew out of the lack of price performance by large cap U.S. equities.
In recent issues we have shown comparisons based on the length of time that this recovery has run from March of 2009 opposed to the start of bull market cycles in 1982 and 2003. The idea was that this is about the time when the S&P 500 Index should flatten out.
The problem with this is that it describes the more defensive of the two scenarios that we have in mind. To help explain the slightly more aggressive option we have included at right our chart of the share prices of Wells Fargo and Carnival Cruise Lines along with the ratio between the Amex Oil Index and S&P 500 Index.
The basic argument- one that we have made many times- is that the recovery begins with the peak for the XOI/SPX ratio. As the oils slowly lose relative strength the stock prices of WFC and CCL were supposed to track higher. So far, so good.
When the ratio broke to new lows around the end of June last year it initiated a positive trend for WFC and CCL that extended for roughly 3 1/2 months into October. As the ratio broke to new lows for a second time in early February our thought was that history was repeating itself- that this marked the beginning of a second positive trend.
Obviously both CCL and WFC have been higher since early February but the point is that if this rally lasts around the same length of time as the one that extended from July into October it won’t end until roughly the end of May. In other words... yet another argument in favor of ‘sell in May and go away’.
