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July 13, 2004

Are There Cycles in Commodity Prices?
by Bonneuil Report

It is interesting to consider commodities from a cycles perspective. This means looking at historical repetitions or patterns in commodity prices that are characterized by similar characteristics and that may have a periodicity associated with their timeframe. If these cycles are deemed to have any merit, projections on commodity prices can be made based upon the periodicity of these cycles into the short-term and long-term future.

Interestingly enough, there have been two fairly in-depth noted historical analyses of cycles in commodity prices. These are as follows:

• the 54-year cycle noted by Edward Dewey and Edwin Dakin
• the 50-60 year cycle noted by Nikolai Kondratieff

These two cycles are discussed below in some detail. Through consideration of these cycles and their associated periodicity patterns, projections on commodity prices to the short-term and long-term future can then be made - whether these projections will be accurate is anyone's guess, but nonetheless they are noted here in this article below.

Edward Dewey and Edwin Dakin

In 1947, Edward R. Dewey and Edwin F. Dakin published a book called Cycles - The Science of Predictions in which they detailed a 54-year index cycle in the wholesale prices going back to 1790 and projections for the future. They called it the 54-year "Rhythm" in their book. In their words:

It is a rhythm that is shown statistically, and most clearly, in wholesale price swings. Interestingly enough, there has been in modern times no pronounced long-time trend in commodity prices - contrary to general belief. The United States, for instance, is old enough as now organized to have experienced three of these 54-year rhythms; during each one, average commodity prices began at a low level, moved (with interruptions) up to a peak, and moved down again (with interruptions) to approximately the level they had sprung from.

The figure below shows the average price charted for the years 1790 to 1945, with an ideal 54-year rhythm indicated in dotted lines. The other figure below it shows the average price but omits the wartime peaks, leaving a gap where they have been eliminated.

Figure 6 - Wholesale Prices from 1800

Figure 7 - Wholesale Prices from 1800 without war effects

Dewey and Dakin note also that in a remarkable study that filled seven volumes J.E.T. Rogers in A History of Agriculture and Prices in England assembled data in wheat prices over several centuries that also reveals a rhythm of average length very close to 54 years.

In particular, Dewey and Dakin forecast these peaks in wholesale prices in their book, which roughly correspond to commodity prices:

Table 5 - Dewey and Dakin Prediction Wholesale Price Prediction Dates

Note that the predicted trough for modern day times is 2006 and that this cycle is projected to rise until 2033 - very positive long-term for commodity prices.

Again these cycles are to be taken with a grain of salt. However, the noted years above and their fairly accurate predictions are quite impressive and interesting.

Consider now another cycle called the Kondratieff cycle, which is much more widely known and in particular, throughout the precious metals investment community.

Nikolai Kondratieff

In 1925, a Russian economist Nikolai Kondratieff published an essay called "Long Economic Cycles" in which he examined trends of commodity prices, interest rates, wages, foreign trade, production, coal consumption, private savings, and gold production as well as political trends from 1790 to 1920 and came to the conclusion that the length of the long wave fluctuates between 48 and 60 years.

The chart below of Figure 8 illustrates and describes the wave in detail, and overlays upon an historical time scale for mapping the trends associated with the wave. The multi-dimensional chart of Figure 8 on the Kondratieff Wave Cycle is very interesting and informative; it is provided by Ian Gordon, editor of The Long Wave Analyst, a client-only newsletter for Canaccord Capital, which develops an investment strategy based upon historical analysis and interpretation of the Kondratieff Cycle. Ian is a licensed Registered Representative and a Vice President of Canaccord Capital.

Specifically, Kondratieff observed the following trends in commodity prices:

• In the rising wave of the First Cycle, commodity prices rose from 1789 to 1814 (25 years); the downward wave of the first cycle began in 1814 and ended in 1849 (35 years); the First Cycle lasted 60 years

• The rising wave of the Second commodities Cycle began in 1849 and ended in 1873 (24 years); the downward wave of the second cycle began in 1873 and ended in 1896 (23 years); the Second Cycle lasted 47 years

• The rising wave of the Third Cycle began in 1896 and ended in 1920 (24 years); according to Kondratieff, the downward wave of the Third Cycle began in 1920; ended likely around 1946; the Third Cycle lasted 50 years

• The rising wave of the Fourth Cycle began in 1946 and ended in 1981 (35 years); the downward wave of the Fourth Cycle began in 1981; ending sometime in the next few years...

• The rising wave of the Fifth Cycle likely beginning sometime within the next few years...

Kondratieff is characterized by each cycle being labeled in terms of the seasons of the weather - spring, summer, autumn, and winter. For each season, general characteristics and conditions are attributed:

Spring - Inflationary Growth Phase - characterized by growth from a depressed economic base and expanding to an ever-increasing spiral; unemployment falls, wages and productivity rise and prices remain relatively stable; mood is one of accumulation and the desire for new product manufacturing

Summer - Stagflation - excess capital produces a shortage of key resources and the economy enters a period where growth creates a shortage of resources; a peak war is characteristic at the end of a very affluent period; rapid rise in unemployment and recession

Autumn - Deflationary Growth - relatively flat growth and mild prosperity; economy is consumption oriented; characteristic is development of new ideas - both technological and social; rapid increase in debt; wealth consumption expands beyond reason and economy goes into severe depression

Winter - Depression - cleansing period for economy to readjust from the previous excesses and begin a base for future growth; technologies of the last period of growth are refined, made cheaper, or more widely distributed; incremental innovation then new period of growth beginning

There has been much discussion by many observers of where the cycle is at this point in time and where the cycle is headed in the next few years. The ending of the cycle has been typically characterized by a purging of debt. This characteristic has not been distinctly apparent as yet, and therefore there is much discussion as to where the present moment stands.

One important point to keep in mind is that the Kondratieff cycle is not a rigorous cycle in terms of cycle length and characteristics; some cycles have lasted more years and some cycles have lasted fewer years. Therefore, there is nothing magical about the cycle lasting a fixed, pre-determined expected number of years.

What is perhaps more important than the cycle length is the set of characteristics of the cycle period; in other words, what events and conditions that the cycle period is experiencing. This point is particularly interesting and concerning in light of the fact that the purging of excessive debt levels has not yet happened in the final phase of the current apparent 4^th cycle now.

The question therefore now is how the purging of current excessive debt levels may come about; there are only two potential scenarios for this purging to occur - the potential scenarios are essentially through a deflationary depression or through an inflationary depression. One of these two scenarios is likely to increasingly manifest itself in the coming years.

We believe that the more likely scenario is an inflationary (hyperinflation) depression scenario much like the historical occurrences of the Weimar Republic and Mexico, and as evidenced by the US Federal Reserve's intention to fight deflation using whatever it takes, including unconventional measures, evidenced by a massive increase in recent years in the ensuing money supply as a result of the Fed's policies and actions. Indeed, it is to be noted that the very definition of inflation by the Austrian School of Economics is an increase in the money supply.

Should this likely scenario of an inflationary depression occur, commodity prices would likely rise substantially. In such an inflationary depression, the increased value of increasingly plentiful US Dollars would likely push commodity prices increasingly higher, given that most commodities are priced in US Dollars. The massive liquidity and depreciating US Dollar resulting from such hyperinflation would likely propel commodity prices to very high levels.

The Bonneuil Report
info@bonneuilreport.com

Disclaimer: Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading. This articles does not constitute a solicitation for the sale or purchase of any security, futures contract, option, or other financial instrument. Those acting on this information are responsible for their own actions. No claim is made that recommendations will be profitable or that they will not result in losses. Copying, re-broadcast or dissemination of this article, in total or in part, is expressly forbidden without prior written permission from The Bonneuil Report.

© 2004 The Bonneuil Report

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