The one trait among investors that is most “everlasting” is the tendency to extrapolate current trends ad infinitum into the future. Until very recently, an entire generation of investors has no idea what a bond bear market looks like – or how to prepare or react for that matter. Despite the fact that interest rates have demonstrated a tendency to rise and fall in roughly 30 year waves, too many investors have never given much thought to the possibility that rates might rise again someday even though rates had been declining steadily since the early 1980’s.
And don’t even get me started on the stock market. The stock market had been on such an unprecedented run (the longest in history without so much as a 3% pullback) until recently that it seemed that no one wanted to even raise the possibility that the market could do anything other than rise indefinitely. Never mind that the stock market by many measures is (or at least was) as overvalued as before the 1929 crash and the 2000 dot com bubble. It is OK to be upset about the recent action in the stock market. It is OK to wonder if this is simply a pullback in a larger ongoing uptrend or the beginning of something much worse. But if you are absolutely stunned that the stock market declined with a bit of ferocity – I hope I am not being indelicate but – WAKE UP! You need to set aside sometime to peruse a 100-year stock market chart and reacquaint yourself with the reality that “the market fluctuates.”
A lot.
Commodities Rising?
Another “thing” that “everybody knows” – or more accurately has become conditioned to believe – is that “stocks are investments” and that commodities are for the “inflation whackos.” The problem of course is that “everybody” doesn’t know squat.
Figure 1 displays a very enlightening chart that displays the ratio between the Goldman Sachs Commodity Index (GSCI) and the S&P 500 Index (SPX). As you can see this ratio clearly “goes to extremes”. And does so on a fairly regular basis. For a period of years commodities vastly outperform stocks and the ratio rises to a peak, and then everything turns and stocks outperform commodities for years at a time. Forgetting even trying to actually time these swings for the moment, note the current reading.
Figure 1 – GSCI Commodity Index / S&P 500 Ratio (i.e., Commodities versus Stocks)
Will the average investor end up being caught completely unaware if commodities vastly outperform stocks over the next 3 to 8 years? I have to believe the answer is “Yes”. But given the extreme recent reading in the GSCI/SPX Ratio I for one am pretty confident that that will be the case.
To better understand the Yinn and Yang nature of commodities versus stocks (i.e., hard assets versus paper assets) consider the results in Figure 2 which displays the performance of the GSCI Commodity Index and the S&P 500 between the peaks and troughs in the GSCI/SPX Ratio highlighted in Figure 1. 
Figure 2 – % Gain/Loss for GSCI Index and S&P 500 Index during various “Trough to Peak” and “Peak to Trough” movements in the GSCI/SPX Ratio
During the 4 “Green trough to Red peak” periods in Figure 1:
*GSCI Index average gain = +289.7%
*S&P 500 Index average gain = +12.4%
During the 4 “Red peak” to “Green trough” periods in Figure 1:
*GSCI Index average loss = (-35.4%)
*S&P 500 Index average gain = +117.3%
Being in the right asset class at the right time clearly makes a difference.
For the record, I am NOT “recommending” commodities. I am simply highlighting the historical back and forth between hard assets and paper assets and the current extreme nature of that relationship.
Also for the record, it is possible to own commodities without trading commodity futures via the use of ETFs. For those interested in exploring further, tickers DBC, GSG and RJI may merit a closer look. These ETFs got crushed between 2008 and 2016, have since rallied sharply and may now actually be a bit overextended.
Summary
So are stocks finished? Is it time to pile into commodities and hard assets? The truth is that it is impossible to identify the exact moment that “the turn” occurs. Still, given the history displayed in Figure 2 and the extreme low recent reading in the GSCI/SPX ratio that appears at the lower right in Figure 1, now might be exactly the time to at least start envisioning an investment future that is significantly different from the current one that “everybody knows”.
Jay Kaeppel
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.
