Commodities march differently than gold

Gold is going higher, so it must be the case that commodities are also going higher? The data tells us otherwise. Commodities, on average, have been rangebound, but the gold versus commodity ratio tells a different story. The gains in gold are the result of something different. It is driven by the demand for a safe asset, not for its use in some production process or for consumption.  

Does this mean that commodity prices should see a gain in the future? There could be a general commodity rise, but it is not in the card based on a ratio. Sometimes a charge is interesting but not informative.

 

Opprtunity cost is the critical measure

 

The simple genius of Charlie Munger: 

“All intelligent people should think primarily in terms of opportunity cost. When deciding whether to do something compare it with the best opportunity you have.”

from farnanstreeetblog.com

Every finance decision, in fact every decision, has to be compared with the opportunity cost associated with the next best decision. Any use of time has to be compared with the next best alternative. Every decision has to be compared against other options every day. This is not supposed to drive a decision maker crazy because there are costs with changing decisions. Still, the idea of continuously measuring the opportunity cost is the basis for improving the use of time, energy, and money.

The loss of dollar dominance

I have written that the dollar decline is significant, but the fall only places the current dollar value near the long-term average. However, we need to acknowledge the extreme moves in the dollar over the last six months. The reason for the dollar decline is truly self-inflicted on the part of the US.

The dollar decline is not driven by systematic factors that would have been picked up by a quant model. The trend/momentum would have called for a short signal, but the exogenous factors have not been seen in past data. Growth in the US is not below the rest of the world. There is the threat of a recession, but the numbers do not suggest lower relative growth. Inflation is still higher than desired, but again the numbers do ot suggest a dollar decline. 

The three areas of concern are uncertainty, trade, and debt. Usually, higher uncertainty will lead to a flight toward safety, but in this case, the uncertainty is with the US. The trade and tariff issue is real, but we lack sufficient evidence of past tariff changes to accurately determine the correct dollar response. In the case of debt, there is clear evidence that large deficits will impact currency demand. Here is where the problem is centered, and there is no clear solution. The current deficits will not be solved with the budgets being suggested. There is a potential credit crisis with the dollar. 

Momentum and reversal related to turnover

 

Momentum is a key factor found across all asset classes. It is persistent and perhaps the most used of the major risk factors. A paper I had not read before provides more light on the topic by showing that you can have both reversal and momentum with 1-month returns if you sort on turnover. The low turnover decile shows short-term reversals, while the high turnover decile shows momentum. See "Short-term Momentum".

Reversal and momentum can coexist once you account for turnover. Large liquid stocks are less sensitive to price pressure effects. The price pressure effect is the main driver for short-term price moves and reversals, but turnover does matter. Don't fight short-term reversal unless you account for the turnover issue.