Today we’re going to talk about commodities.
Commodities are one of my favorite asset classes to trade. Crude oil, natural gas, and cocoa are renowned for their volatility.
And for traders, volatility is an amazing thing. It’s what allows us to capture those big moves that go both up and down.
Of course, for investors, volatility is a lot less desired.
You generally want your investments to provide stable returns over a long period of time.
And when it comes to quality as an investment, there’s no doubt that stocks have greatly outperformed commodities over the long run.
One way we can measure the performance of commodities relative to stocks is by looking at the S&P 500 and Producer Price Index (PPI) ratio.
The PPI is an economic index that measures the average changes in price for the raw materials – commodities – that producers require in order to manufacture their goods.
So while the S&P 500 and the PPI can both rise simultaneously, we can still track the relative performance of each market.
By looking at the S&P 500 / PPI ratio, we can assess how stocks and commodities have behaved at various times in the past.
You can check out the S&P 500 / PPI ratio in chart form below:
When the ratio is rising, it means that stocks are outperforming commodities. And when the ratio falls, it means commodities are outperforming stocks.
As we can see, stocks have soundly outperformed commodities over the decades.
In fact, if you look closely at the ratio chart, you’ll notice something very interesting…
I’m talking about the periods when commodities do outperform stocks.
Those relatively rare periods coincide with significant downturns in the stock market. For example, the dot-com crash of 2000, the financial crisis of 2007-2008, and the more recent 2022 bear market.
And what the ratio chart is telling us right now is that commodities are historically underpriced relative to stocks.
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Now, I’m not suggesting that the next market crash is immediately at hand.
In fact, if you’ve been reading my writing, you’ll see that I’ve maintained a bullish stance when it comes to trading.
But what I am saying is that when the next market crash happens, traders and investors would be wise to pay very close attention to commodities.
That’s the corner of the market that’s likely going to explode.
And given how the stocks to commodities ratio is currently sitting at fresh all-time highs, I certainly expect the next commodities boom to be one for the ages.
Happy trading,
Imre Gams