Hussman On The Commodities Run

John Hussman discusses the commodity runup and a signpost to watch for clues to when it might end.
I am pasting in the discussion but this is only a portion of his commentary which i read regularly.

It is accurate intuition that commodities are
generally stronger in economic expansions than they are in
contractions, but that intuition can fail when U.S. real interest rates
are negative. At those times, the heavy downward pressure on the U.S.
dollar tends to be supportive for commodities. Given that commodities
have already had an extremely strong run, it would be overly
speculative to take positions here on the expectation that the run will
continue, but the evidence suggests that we should expect a serious
break only when the rate of inflation breaks.

As
a simple way to capture the pattern, we can define the economy as
“strong” or “weak” depending on whether the ISM Purchasing Managers
Index is above or below 50. We can capture real interest rate pressures
by noting whether the latest year-over-year CPI inflation rate is above
or below the 10-year Treasury yield. This is not a true “real” interest
rate measure, but it generally captures periods where recent inflation
is high or accelerating and bond yields are not particularly supportive
of the U.S. dollar. Using the recent CPI inflation rate (overall, not
core) also introduces a “trend following” component, since rising food
and energy prices will push up that year-over-year rate as well.

Most
of the past half-century has been associated with an ISM above 50 and a
CPI inflation rate below the 10-year Treasury yield. During these
periods, the CRB index has increased at a modest average rate of about
4.3% annually. When the ISM has been below 50, with CPI inflation below
10-year Treasury yields, the CRB has declined at an average rate of
-5.4% annually. So there is certainly evidence to suggest that
commodity prices are vulnerable during periods of economic weakness.

When
CPI inflation is running higher than 10-year Treasury yields, the
pattern is different. This doesn't happen often, but the return
differences are large enough to be statistically significant despite
the small sample size. During these periods of downward real interest
rate pressure, the CRB has advanced at an average rate of 10.0%
annually when the ISM has been above 50, and 39.6% annually
when the ISM has been below 50. This result has been largely due to
downward pressure on the value of the U.S. dollar.

In
short, my impression is that the commodities run, though increasingly
extended and dangerous, may have a final push due to further weakness
in the U.S. dollar. Most likely, as we approach the second half of
2008, rising credit problems will reduce monetary velocity enough to
finally put a lid on the rate of inflation. At the point where the
year-over-year CPI rate drops below 10-year Treasury yields, most of
the damage to the U.S. dollar will likely have been done (even if the
economy weakens further), and that's probably when commodities will
become poor speculations

Hussman Funds - Weekly Market Comment