Its called deflation and its here

Change in selected commodity prices for the three months ending June 22nd 2012

Market convention is to quote most commodities in the world’s reserve currency, the US Dollar. Therefore, in dollar terms, as the US currency weakens commodities – holding all over variables such as supply & demand constant – increase in price. This makes sense, as it takes more of the weaker US Dollars to purchase the commodities. The opposite applies when the US Dollar strengthens; in other words, commodity prices are expected to decline. The chart above shows the performance of selected commodities – Energy, Industrial Metals, Agriculture, Precious Metals and Livestock – over the last three months. There is has been an overall collapse in commodity prices, with energy leading the way down with a sharp decline of -23.25%. So why are commodity prices falling so much? Is the US Dollar getting that strong? Hardly. The US Dollar has indeed strengthened, as evidenced by the chart below but only by a mere 3.26%. So what’s going on? Well the global economy is slowing even as deflationary forces – in the form of write-offs and defaults – surge out of Europe. We’ve all heard of contagion, and the deflationary contagion is spreading. The silver lining to deflation? Just this month US consumer prices tumbled the most in three years. Deflation, in other words.

If we’re seeing it The Fed is seeing it as well; can QE 3 be far off? I don’t think so.

Change in the US Dollar Index for the three months ending June 22nd 2012

Change in the US Dollar Index for the three months ending June 22nd 2012

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