From the April 01, 2011 issue of Futures Magazine • Subscribe!

Commodities and the law of gravity

Since 1804 there have been five major tops in commodities that have occurred anywhere from 30 to 45 years apart. The average 10-year return for all major overall commodity peaks was 7.6%. That means that when such a level is reached or exceeded, commodities have entered the overvalued category and are in a dangerous position for a major correction. Energy commodities always have outperformed all others and have shown a 10-year average return of 15% to 20% at peaks. In 2008, the energy complex reached a 10-year average return of 20% just before crashing, as would have been predicted from the DNA of its history. The all-time record overvalued commodity market was the top set in 1980. "Feeling a little toppy" (below) looks at the period from 1966 to the present.

Click on the chart above to enlarge.

You can see that the all-time record overvaluation, using the 10-year average return metric, in the CCI (continuous commodity index) occurred in 1980 at 12.37%. The interim peak set in 2008 occurred just underneath that level at 10.75% before crashing. Currently, overall commodity markets are even more overvalued, having reached 11.25% by the end of January 2011 and since have risen further in the month of February. This suggests that overall commodities are currently near the most overvalued levels in 200 years.

Anyone who ignores this startling fact should do so at their own peril. Also, keep in mind that it has been 30 years since the last major commodity top. That places the current bull market in the historical 30- to 45-year duration between commodity peaks. Maybe it will be different this time and maybe we will rewrite 200 years of commodity pricing behavior and set a new normal for commodity valuations for generations to marvel at, but maybe not. The odds do not favor this bullish paradigm shift and instead suggest that a nasty spill in overall commodities likely is imminent. This is not the time to be all in on buying commodities. This is a time to be looking at the short side of the equation as fortunes will be made when the "Law of Gravity" takes hold and works it magic, and sets commodity markets back down in a normal corrective process.

We can’t be sure a major turn is imminent, but the likelihood of a significant correction similar to what occurred in 2008 is high. It would be perfectly normal to expect a 20% correction in overall commodities at some point in 2011. The time to buy will be then and not now.

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