Wells Capital Management

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Economic and Market

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August 4, 2015

Commodity Price Selling Climax?

James W. Paulsen, Ph.D
Chief Investment Strategist,
Wells Capital Management, Inc.

Recently, a sharp selloff in the Shanghai stock market

followed by renewed weakness in commodity prices has
intensified concerns that the Chinese economy is weakening
significantly and has heightened anxieties surrounding
the risk of a global deflationary spiral. However, as Chart 1
illustrates, the recent collapse in U.S. commodity prices is
probably due more to a strong U.S. dollar than a collapsing
Chinese economy. Commodity prices in the U.S. seem to be
joined at the hip with movements in the real U.S. dollar. Based
on monthly data, their correlation since 1990 is a very strong
inverse relationship of -0.96.
We believe recent volatility in the U.S. commodity markets
probably represents a normal (and highly emotional)
bottoming process after a severe decline last year rather than
increasing evidence of a global slowdown. Likewise, we think
the U.S. dollar is probably in a peaking process. The S&P GSCI
Commodity Price Index is currently very close to its bottom
first reached in late January and the U.S. real dollar peaked
in March. Most believe commodity prices will fall still further
and expect the U.S. dollar to climb even higher. Perhaps
this will prove to be correct. However, if the strong dollar,
weak commodity price trend is in the process of changing,
as we expect, it could result in significant financial market
turbulence since many portfolios will need to be adjusted.
Moreover, if the U.S. dollar does surprisingly peak and
commodity prices bottom, the calculus surrounding any Fed
exit strategy would also likely be abruptly altered. Particularly,
if dollar weaknesscommodity price strength occurred as
wages showed signs of acceleration.

Our best guess is the markets are currently in the late stages
of a selling climax in commodities and commodity-related
securities. We recommend investors begin to take advantage
of the recent carnage and look to increase exposure on
weakness to commodities (perhaps directly via exchange
traded notes), to commodity stock market sectors (materials,
energy, or industrials), or to commodity-biased stock markets
(e.g., Canada and Australia). We also think emerging markets
will likely do well again once the U.S. dollar peaks renewing
some strength in commodity prices.
In any event, as the chart suggests, the U.S. dollar and
commodity prices are a singular event. When the time does
eventually come, the financial markets will have to deal
simultaneously with two major trend changesa peaking
U.S. dollar and a bottoming in commodity prices.

Chart 1
U.S. commodity prices versus U.S. Dollar Index
Left scaleS&P GCSI Spot Commodity Price Index, natrual log scale
(Solid)
Right scaleU.S. Real Broad Trade-Weighted Dollar Index, inverted
scale (Dotted)

Economic and Market Perspective | August 4, 2015

Written by James W. Paulsen, Ph.D.

An investment management industry professional since 1983, Jim is
nationally recognized for his views on the economy and frequently
appears on several CNBC and Bloomberg Television programs, including
regular appearances as a guest host on CNBC. BusinessWeek named him
Top Economic Forecaster, and BondWeek twice named him Interest Rate
Forecaster of the Year. For more than 30 years, Jim has published his
own commentary assessing economic and market trends through his
newsletter, Economic and Market Perspective, which was named one of
101 Things Every Investor Should Know by Money magazine.

Written by James W. Paulsen, Ph.D., Chief Investment Strategist, Wells Capital Management, Inc., a business of Wells Fargo Asset Management
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