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Probability Of Rising Commodity Prices Causing A Stock Market Crash Is Very Low

 February 28, 2012 12:27 PM

Some analysts have argued that the recent rise in commodity prices and especially the rally in crude oil prices may cause a stock market crash. However, the current situation does not compare to the conditions present in 2007 and 2008.

Rising oil prices do not suffice to cause a stock market crash. There must be in addition a spillover effect into other commodities. The chart below shows weekly prices of S&P 500 index (blue line) and of the Dow Jones – UBS Commodity Index (red line – own price axis not shown).  It may be seen that the value of the index is nowhere near levels that were realized during the market crash that started in 2007:

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As a matter of fact, it may be seen from the chart that the stock market decline of 2007 started way before the commodity index peaked. This does not mean that the stock market crash caused the commodity decline as some may think and also have argued. It means that while the S&P 500 index was trying to find support near 1300, commodity prices continued to rally and that created panic to investors about future prospects of the economy. Commodities declined because of recession fears, not because of the market decline.

The situation during that time (2007 – 2008) was different from current conditions. Since the start of this years, metals have rallied, cocoa has gained near 15%, heating oil is up about 13%, crude oil is up about 10%,  lumber and sugar have gained about 9%,  and soybeans about 7%. These are modest gains. At the same time, wheat prices are down 1.5% and rice prices are down about 5%. The biggest decline is in natural gas, close to 17%.

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Thus, the situation is in no way even remotely similar to what occurred back in 2007 and 2008, when wheat and rice prices were more than double their current levels.  Thus, the probability of a stock market crash induced by higher commodity prices is very low at this point. It will get higher if crude oil prices rise above $130 and at the same time other commodities, especially grains, rally to multi year highs.

Disclosure: no relevant positions.

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