A Monday Morning Musing from Mickey the Mercenary Geologist
Contact@MercenaryGeologist.com
November 14, 2014
A multitude of mavens,
pundits, sages, wizards, writers, and assorted talking heads with various but vested
interests in the hard commodities sector have weighed-in on the supposed demise
of the secular bull market in “stuff” over the past few months.
Reactions have been varied
but predictable: the usual suspects in the gold- and silver-bug camps have
played the market manipulation card to explain the overall weakness in precious
metals prices; the China perma-bears have claimed the downtick in industrial commodities to be a foreshadowing of the
pending collapse of that country’s decade-long economic growth; and the
hyper-inflationists have determined the cause to be big banks that will not
loan their growing stashes of Federal funny money, thus leading to decreased
demand for industrial metals and energy. Meanwhile, the deflationists have
stated we are simply living in a deflationary economic environment. Many have
commented on US dollar strength as a contributing factor to lower commodity
prices.
I say nonsense to most of the
above. In the words and charts that follow, I will provide irrefutable evidence
that the weakness in hard commodities over the past four months can be overwhelmingly
attributed to the strength of the US
dollar. My argument is based on elementary statistics, a general math
requirement to earn a college degree.
As an aside, I had14 hours of
high-level mathematics beginning with engineering calculus in college, but did
not take statistics, a low-level course that would not credit toward my undergraduate
degree. However, it was a requirement when I entered graduate school at the
University of New Mexico. To get around taking a freshman-level math class, I
convinced the geology department that a course shown as “Statics and Dyn” on my
undergrad transcript, was a sophomore statistics course. In actuality, it had
nothing to do with statistics but was a civil engineering course called “Statics
and Dynamics”. LOL.
Let’s
start by reviewing a key concept in statistical analysis: the correlation
coefficient. I’m sure this is way more than most of you need or want to know
but realize I’m a scientist who strives to help lay people understand the
concepts and evidence that support my opinions.
Correlation can be defined as the systematic relationship between
two variables. The correlation
coefficient is an equation that exactly quantifies the linear relationship
between data sets.
A perfect
positive correlation coefficient (+1) means that when one variable increases
the other also increases in an exact relationship; these data will plot as a
straight upward-trending line on an x-y graph. A perfect negative or inverse
correlation coefficient (-1) means that as one variable increases the other
decreases in an exact relationship; data will plot as a straight downward-trending
line on an x-y graph. Complete randomness between two variables, a non-linear
correlation, or other confounding variables all result in a 0 value and the
data will be scattered across an x-y graph.
The
really important thing to note here is the correlation coefficient is a number that
ranges from +1 to -1.
However,
rarely in the real world of measurements, values, prices, or whatever will the
relationship be absolutely perfect between
two variables.
As
you know, I like rules of thumb and they certainly apply here. The following parameters
are used by statisticians to categorize the correlation between two variables:
·
Correlation coefficients
between 0.9 and 1.0 indicate variables that are very highly correlated.
·
Correlation coefficients
between 0.7 and 0.9 indicate variables that are highly correlated.
·
Correlation coefficients
between 0.5 and 0.7 indicate variables that are moderately correlated.
·
Correlation coefficients
between 0.3 and 0.5 indicate variables that have low correlation.
·
Correlation coefficients
less than 0.3 have little if any linear correlation.
Whew!
Now
that we’re finally done with freshman statistics class, let’s look at four-month
charts for the US Dollar Index (DXY) and the three major hard commodities
(gold, copper, and oil) that are listed on integrated world exchanges. That
means they are traded in US dollars via both physical (spot) and paper (futures,
options, warrants, and ETF) markets.
A quick perusal of the first chart illustrates the recent
strength of the US dollar with respect to a basket of world currencies (British
pound, Canadian dollar, Euro, Japanese yen, Swedish krona, and Swiss franc).
Four months ago, the US dollar index (DXY) was commencing its upward march; it
has gone from 80.19 on July 11 to 87.60 on November 11 for a gain of over 9%:
Meanwhile,
prices for the world’s most important precious metal (Au), its major industrial
metal (Cu), and its North American energy benchmark (WTI) have all weakened significantly.
From
July 11, when New York gold closed at its highest price since mid-March at $1339 an ounce, it has fallen to $1163.
That’s a loss of 13%:
During this same period of time, Comex spot copper
went from $3.24 to $3.06 per pound, a drop of 6%:
Concomitantly, the West Texas Intermediate crude
oil price has collapsed from nearly $106 to just under $78 a barrel, off a
whopping 26%:
My contention
that the 4-month weakness in commodity prices is directly due to the strong dollar
is shown by the following correlation coefficients and charts. I think they are
self-explanatory:
Further evidence supporting my premise is a 4-month
chart showing the price of gold in Euros. Note the relatively minor 5% drop from
€ 984 to € 933, compared to the aforementioned 13% loss in US dollars:
The
four-month commodity and dollar data produce
very high to high correlation coefficients at
-0.96
for gold, -0.85 for copper, and -0.90 for oil.
Although
spot commodity prices are based on short-term supply and demand fundamentals, many
other factors affect their daily fluctuations. Included are industry news,
world events, geopolitics, weather, and natural disasters. Additionally, a good
deal of gaming, arbitrage, and attempts at manipulation are thrown into the mix
with traders and speculators trying to generate short-term profits via the
paper and derivative markets.
Considering
these often competing factors, I view the high negative correlation
coefficients of the dollar index and major hard commodities over the past four
months as quite remarkable.
My
basic statistical analysis has shown the recent drops in major world commodity
prices are simply due to the strength of the world’s reserve currency, the
almighty US dollar. This much-maligned
fiat currency has suddenly and once again become the world’s go-to safe haven.
It
is my contention that given the current world economic paradigm, which includes
a slowdown of growth in China, continuing struggles in other emerging market
countries, European banking and currency woes, and an incipient recovery in
America, the US dollar will continue to rise with respect to other major currencies.
And
a higher DXY implies further deterioration in the US dollar price of all hard
commodities traded on the world stage.
Ciao
for now,
Mickey Fulp
Mercenary Geologist
The Mercenary Geologist Michael
S. “Mickey” Fulp is a Certified
Professional Geologist with a B.Sc. Earth Sciences with honor from the
University of Tulsa, and M.Sc. Geology from the University of New Mexico.
Mickey has 35 years experience as an exploration geologist and analyst
searching for economic deposits of base and precious metals, industrial
minerals, uranium, coal, oil and gas, and water in North and South America,
Europe, and Asia.
Mickey worked for junior explorers, major
mining companies, private companies, and investors as a consulting economic
geologist for over 20 years, specializing in geological mapping, property
evaluation, and business development. In
addition to Mickey’s professional credentials and experience, he is
high-altitude proficient, and is bilingual in English and Spanish. From 2003 to
2006, he made four outcrop ore discoveries in Peru, Nevada, Chile, and British
Columbia.
Mickey is well-known and highly respected throughout
the mining and exploration community due to his ongoing work as an analyst, writer,
and speaker.
Contact: Contact@MercenaryGeologist.com
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