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'Severe deflation': Everything depends on rising stock market, even commodities - Bloomberg Intelligence

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(Kitco News) The stock market needs to keep on rising to avoid deflation, which is weighing on commodities even in light of all the quantitative easing introduced last year, according to Bloomberg Intelligence.

"Bouncing commodity prices and bond yields are at greater risk of succumbing to more enduring downtrends. The fact that the world's most important commodity -- crude oil -- is the same price it was 16 years ago, despite unprecedented levels of monetary and fiscal stimulus, indicates entrenched deflationary forces," Bloomberg Intelligence senior commodity strategist Mike McGlone said on Monday. "Clear deflation is our take from the unchanged price of the world's most significant commodity since 2005, despite a 200% rise in U.S. M2 money supply."

Bloomberg Intelligence described this as possibly "the most deflationary period in history," adding that commodities could be at risk of a price collapse.

"Commodities may be at similar risk as they were prior to the oil-price collapse in 2014. Our graphic depicts the Bloomberg Commodity Spot Index 60-month rate-of-change potentially peaking at the same measure of U.S. M2 money supply in a similar pattern as it did seven years ago. Crude oil plunged to a bottom of about $25 in 2016 from over $100 a barrel in 2014," McGlone wrote. "Unless WTI can sustain above $70 a barrel, there's little to stop more of the same deflationary forces from commodities that marked a top in the U.S. Treasury 10-year yield of about 3% in 2014."

In order to fully understand the deflationary forces at play, McGlone looked at what market conditions would be like without the massive money printing that the world saw over the last year.

"Our graphic depicts the inability of spot gold and commodity prices to keep up with rapidly rising U.S. M2 money supply. Since the start of 2008, the Bloomberg Commodity Spot Index is down almost 60% vs. M2. Juxtaposed is the S&P 500 Total Return beating M2 by about 40%. This disparity emphasizes the significant deflationary risks to some stock-market reversion," he wrote. "Commodities are providing little buoyancy for inflation and would be much lower absent M2, increasing about 160% from just prior to the financial crisis."

The stock market would need to keep rising in order to avoid deflation since the significant global quantitative easing is still having trouble keeping up with deflationary forces, especially coming from commodities, McGlone concluded.

"The Bloomberg Commodity Spot Index is down almost 10% from just before the collapse of Lehman Brothers in 2008. This may not seem like much of a price decline, but when put in the context of G4 central-bank balance sheets jumping to about 56% of GDP from closer to 10%, our take is that's severe deflation. Imagine where inflation levels would be if central banks didn't prime the pumps and governments weren't rapidly boosting debt-to-GDP levels," he said. "A decline in the S&P 500 would have severe deflationary implications."

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