Backwardated commodities are beating stocks - A rotation to the real economy

Is there a new commodity super-cycle? It does not matter. A recovery cycle in a global economy flush with cash has been enough to take the main commodity index to returns beyond the SPY equity index for 2021. In a constrained real economy with high liquidity, money will flow first to financial assets, but with economic recoveries expected to be robust, the demand for commodities has strengthened. However, which commodities will rise from here is still variable. 

  

In April, the big winners were core agriculture markets, corn, wheat, and soybeans. This jump is a little early given planting periods, but increased demand and dry conditions have excited speculative long buying with export demand expected to be strong. Prices for corn are approaching the dramatic 2011 levels. 

Corn prices are at 2011 levels and we still have a lot of weather uncertainty. 

Soybean prices are also at multi-year highs. 

It has been reported that USDA agriculture exports were the second highest on record in 2020; the highest export year was in 2014. It may be even higher this year if China meets purchasing estimates from our China-US trade agreement. Adverse weather in South America coupled with mixed expectations for conditions in the US has kept speculative interest strong. 

The BCOM index is in strong backwardation, the highest we have seen in decades so holding long commodity indices is attractive even if there is no strong higher price move . 

 

The half-life of facts - it can be an investment problem

A provocative book from 2012 is The Half-life of Facts: Why everything we know has an expiration date by Samuel Arbesman. I was intrigued by the title and found the conclusions surprising. I know that science is rapidly changing, and we are constantly adding to our knowledge, but I may not fully appreciate how change, evolution, and facts are integrated to create the dynamic knowledge environment we inhabit. 

Knowledge is not just a process of addition. It is also a process of subtraction. We are constantly finding facts that are wrong and do not stand the test of time. Our increased pace of discovery means that more of what we may have held as true is now false. There is a half-life for knowledge. Different fields have different half-lives, and research is constantly being overturned. From Thomas Kuhn and his monumental work, The Structure of Scientific Revolutions, we have learned that science can have paradigm shifts. These can only occur when our facts shifts. Changing facts need new theories which creates shifts in science. From the book, a figure and table on half-lives. 

The speed of knowledge diffusion is increasing, but with so many facts and knowledge being created, there is the potential for hidden information. Knowledge may be created but not disseminated. 

This does not mean that we shouldn't learn facts. It also does not mean there is not truth, or all knowledge is relative. This is not a perception or feelings issue. It is a progress issue. 

The impact on finance and investment is significant. The academic studies of the past will likely be overturned. The ideas that drove investment decisions a decade ago may not be true today. Our common knowledge may be wrong. Assumptions concerning market behavior are subject to change. This half-life of finance facts creates potential for investment failure. For those that are gathering and assessing new facts, there is opportunity for profits, at least for a time.

NY Fed staff nowcast - Still strong for second quarter

The NY Fed staff has developed a good nowcast for GDP that effectively competes with the Atlanta Fed GDPnow forecasts. These are good tools for extrapolating current economic data into a GDP forecast. 

It is a little tricky to look at these numbers the first time. The NY Fed nowcasts GDP during the quarter and during the calculation period (the beige colored area), The prior quarter is in green, and the next quarter is in purple. Given how information is generated, the Fed will track the first quarter through the first month of the second quarter. Clearly, the first quarter was predicted to be very strong. Second quarter is expected to come in weaker but still above long-term trends. There may be a reason to see some tempering in financial markets in the second quarter, but the growth still strongly supports holding risk assets. 

NY Fed weekly economic index off the charts

 

From the great business cycle economist Victor Zarnowitz comes an old rule for recessions - the deeper and more dramatic the decline in the business cycle, the more likely there will a steep recovery. Well, we are really seeing that with the US economy. 

The chart above shows the NY Fed weekly economic index scaled to align with the four-quarter GDP growth rate. It is off the charts. We are almost completely back to old levels. Now, there will be nothing like going back to the pre-COVID world. Tastes have changed. Businesses have changed. Productivity has changed, but it is hard to argue that there is a disconnect between the financial and real economy when we see these types of numbers. 

There are good arguments on whether financial markets are overdone. Overshooting should not be surprising, but there are real recovery reasons for the equity strength. Investor concerns should not be with the recovery but with any downside surprise when everyone is thinking the same. 

The WEI represents the common component of ten daily and weekly series covering consumer behavior, the labor market, and production, including: 

• Initial unemployment insurance claims
• Continuing unemployment insurance claims
• Federal taxes withheld
• Redbook same-store sales
• Rasmussen Consumer Index
• The American Staffing Association Staffing Index
• Raw steel production
• U.S. railroad traffic
• U.S. fuel sales to end users
• U.S. electricity output