A stock operator's thoughts and ideas about market principles
Stock Trader and
Economy Student
J.P. Janssen's website.The purpose of the site is to discuss ideas and principles about markets. More |
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The Special Sections Relative Sizes Quotes The Domino Effect |
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Recommended Books The Edu. of a Speculator 
Practical Speculation 
The Black Swan 
Fooled by Randomness 
Market Wizards 
Reminis. of a Stock Operator 
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Recommended Websites Daily Speculations Science Daily CIA World Factbook Project Gutenberg LibriVox |
Jan/07/2010
Know the Price
Every few years, stocks, commodities and just about anything with a price tag reach new "all time highs.". The main reason, as you know, is inflation.
A solution to this problem is to adjust for inflation. Official CPI numbers are availiable, so that updating the prices is not a big operation.
Unfortunately the CPI figures are not perfect. First, there is no universal way of weighing the numerous consumer goods and services. Second, political biases should be expected.
My solution is to avoid the CPI altogether.
If I had bought American stocks fifteen years ago, and they had followed the DJIA index perfectly, the price path would have looked like this:
My price path on the other hand would have been this:
The reason is that when I buy American stocks, I exchange NOK (Norwegian Kroner) to USD and exchange back when I sell. The above graph still suffers from the inflation problem though, since NOK, like all currencies, changes value over time.
An option is to make my personal index, where I every month state how much one NOK means to me. But any number would be somewhat arbitrary.
This problem is eliminated when the prices of two never-changing units are compared. An ounce of gold today is the same as an ounce of gold was a hundred years ago. And so it will still be a hundred years into the future. The samme applies to pound of coffee, a bushel of oats, and every standardized commodity out there.
Think of a Brazilian coffee farmer. The second best use of his land can for example be to produce sugar. His opportunity cost looks like this:
Most farmers, I'm sure, know roughly how much of the second-best crop they may produce. Two-three years ago a farmer would only have needed to produce a tenth as much robusta coffee as potential sugar, for coffee to be worthwile. Today this ratio is three times higher. Farmers are right now cutting down their coffee trees and planting sugar canes.
For an instant-coffee brand, the relevant price picture could be this:
The coffee company needs to balance the use of cheap robusta with the popularity of the brand. Certainly, more expensive arabica (measured in robusta) will not reduce the use of robusta.
I have a database with historic prices of hundreds of commodities, stocks, currencies and indexes. This enables me to see tens of thousands of graphs, each with its own unique story. More importantly, I know whether "all time high" really is the high of all times or simply an inflationary illusion.
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