Comparison of the bond and commodity markets begins with the events leading up to and following the major turning points of the 1980-1981 period which ended the inflationary spiral of the 1970s (a period when a number of financial workers had to refer to a job search) and began the disinflationary period of the 1980s This provides a useful background for closer scrutiny of the market action of the past five years. The major purpose in this chapter is simply to demonstrate that a strong inverse relationship exists between the CRB Index and the Treasury bond market :o suggest ways that the trader or analyst could have used this information to advantage Since the focus is on the Commodity Research Bureau Futures Price Index a bnet explanation is necessary.
The CRB Index, which was created by the Commodity Research Bureau in 1956, Presents a basket of 21 actively-traded commodity markets. It is the most widely-watched barometer of general commodity price trends and is regarded as the commodity markets' equivalent of the Dow Jones Industrial Average. It includes grams livestock, tropical, metals, and energy markets. It uses 1967 as its base year. While other commodity indexes provide useful trending information, the wide acceptance of the CRB Index as the main barometer of the commodity markets, the tact that all of its components are traded on futures markets, and the fact that it is the only commodity index that is also a futures contract itself make it the logical choice for intermarket comparisons. In Chapter 7, I'll explain the CRB Index in more depth and compare it to some other commodity indexes.
The 1970s witnessed virtual explosions in the commodity markets, which led to spiraling inflation and rising interest rates. From 1971 to 1980 the CRB Index appreciated in value by approximately 250 percent. During that same period of time bond yields appreciated by about 150 percent. In November of 1980, however a collapse in the CRB Index signaled the end of the inflationary spiral and began the disinflationary period of the 1980s. (An even earlier warning of an impending top in the commodity markets was sounded by the precious metals markets which began to fall during the first quartet of 1980.). Long-term bond rates continued to rise into the middle of 1981 before finally peaking in September of that year.
The 1970s had been characterized by rising commodity prices and a weak bond market. In the six years after the 1980 peak, the CRB Index lost 40 percent of its value while bond yields dropped by about half. The inflation rate descended from the 12—13 percent range at the beginning of the 1980s to its lowpoint of 2 percent in 1986. The 1980 peak in the CRB Index set the stage for the major bottom in bonds the following year (1981). A decade later the 1980 top in the CRB Index and the 1981 bottom in the bond market have still not been challenged.
The disinflationary period starting in 1980 saw falling commodity markets along with falling interest rates (see Figure 3.1). One major interruption of those trends took place from the end of 1982 through early 1984, when the CRB Index recovered about half of its earlier losses. Not surprisingly during that same time period interest rates rose. In mid-1984, however, the CRB index resumed its major downtrend. At the same time that the CRB Index was resuming its decline, bond yields started the second leg of their decline that lasted for another two years. Figure 3.2 compares the CRB Index and bond yields on a rate of change basis.
FIGURE 3.2
THE LINKAGE BETWEEN THE CRB INDEX AND TREASURY BOND YIELDS CAN BE SEEN ON A
12-MONTH RATE OF CHANGE BASIS FROM 1964 TO 1986. (SOURCE: COMMODITY RESEARCH
BUREAU, 75 WALL STREET, NEW YORK, N.Y. 10005.)
The rising bond market and falling CRB Index reflected disinflation during the early 1980s and provided a supportive environment for financial assets at the expense of hard assets. That all began to change, however, in 1986. In another example of the linkage between the CRB Index and bonds, both began to change direction in 1986. The commodity price level began to level off after a six-year decline. Interest rates bottomed at the same time and the bond market peaked. I discussed in Chapter 2 the beginning of the "head and shoulders" bottom that began to form in the CRB Index during 1986 and the warning that bullish pattern gave of the impending top in the bond market. Although the collapse in the bond market in early 1987, accompanied by a sharp rally in the CRB Index, provided a dramatic example of their inverse relationship, there's no need to repeat that analysis here. Instead, attention will be focused on the events following the 1987 peak in bonds and the bottom in the CRB Index to see if the intermarket linkage holds up.