Since hitting an all-time high on July 3, 2008, the benchmark Reuters-CRB Index has declined 24% while crude oil prices have tanked 29%. Other commodities have declined even more. Oil stocks, as measured by the Spiders XLE Index (XLE), are down 31% from their highs, while the Dow Jones Oil Equipment and Services Index is off 32% from its best level. And gold stocks, as measured by the XAU Gold & Silver Index, are down a blistering 45% since June, trading at the same levels as November 2005.

In percentage terms, the current decline for commodities is the worst draw-down since the summer and fall of 2006, when the CRB Index tanked more than 16% from its highs.

Is this the end of the commodity bull market? Is a slowing global economy signing the final death knell for raw materials after a wicked seven year bull market?

Not a chance…

Heavily Overbought Heading into July; Dollar Surge Hurts

Admittedly, the recent peak in oil prices was extreme, if not symptomatic of a short-term “bubble.” The same was true for most commodities, where institutional fund-flows were manic in the hunt for positive returns during the first six months of 2008.

Commodities have been the prime recipients of a global institutional boom through the creation of exchange traded funds and an influx of hedge fund money seeking exposure to one of the few remaining profitable segments of the market in an otherwise horrible year for equities and bonds since last fall.

The “big trade” over the last 12 months for hedge funds has been riding the wave in commodities, including oil and shorting or betting against financial stocks. That trade violently reversed in July.

Another dose of bad news for commodities lately is the dollar’s rapid recovery.

With the dollar in a freefall over the last few years, investors had scrambled to hedge their portfolios against rising inflation and a decaying currency. But that trend is over, at least for now. Longer term, the dollar is relegated to the dustbin as a laundry list of deficits hamper any serious gains or bear market rallies.

Don’t Sell Commodities!

Commodities, including oil, are in a correction and not at the cusp of a bear market.

The market is right to discount a slowing global economy this year as credit problems and stagflation spread to overseas economies; but it’s wrong to assume that the bull market in oil and most other commodities is over – not with short-term cash rates still below the rate of inflation and global money-supply (M-2) growing in excess of almost 20% year over year, according to Grant’s Interest Rate Observer.

Any way you slice it or dice it, this has been a bruising correction. But don’t call it a bear market. Commodities, unlike stocks, are far more volatile and can record daily price swings that are extremely wild – exceeding 5% or even 10% in a single day.

But here’s some compelling market-based data that supports my view that commodities are in a correction, not a bear market.

Bull markets in commodities don’t end with negative inflation-adjusted interest rates or with global money-supply (M-2) expanding at more than 20%. In the 18 years I’ve been in this business I’ve never seen credit expand at that rate – never. This tells me world governments are growing desperate to grow inflation amid a deflation in credit expansion and real estate. It’s inflate or die for the world’s central banks.

Remembering the 1970s Correction

Commodities are extremely volatile and pegging this decline a bear market because prices are down 20% is ridiculous. Oil, gold and other commodities plunged by almost 50% in the mid-1970s amid a huge bull market before going utterly gangbusters by 1980. Commodities can decline sharply even in a secular bull market.

But what about the U.S. dollar and its impressive 360-degree turn since mid-July against all major currencies? Isn’t that a bad omen for commodities?

What’s amazing is that everyone is running to buy dollars when the United States is still accumulating out of control deficits.

Spending out of Control

The Treasury’s budget deficit in July nearly tripled to $102.77 billion dollars, up 182% from July 2007. But what difference does it make? The U.S. just spends like crazy and the rest of the world finances this ponzi-scheme. It might not be this year or next year; but at some point there will be a global crisis in confidence as America’s debt-to-GDP ratios, already at 6%, just explodes to uncontrollable levels.

It’s not just budget deficits that threaten the dollar. There’s also trade deficits as far as the eye can see; two seemingly endless and expensive military conflicts; bulging social entitlement spending programs that have yet to peak; more financial institution bail-outs and the eventual nationalization of Fannie Mae and Freddie Mac. The list goes on and on…

How can a sensible investor not own gold and other tangibles in this madness?

In order for the United States to support all of this profligate spending it must expand credit or print money. And printing this sort of money – a colossal amount – will ultimately result in much higher inflation in 24-36 months.

Deflation versus Inflation

Let me confess something to you: Most analysts, gurus and hedge fund managers have absolutely no clue what’s going on – and haven’t since mid-July. Markets are upside down.

The way I see it, investors are confused because they can’t interpret the current stage of the economic cycle; are we still in an inflationary surge or is this the beginning of global deflation?

It’s this seemingly new direction in asset prices since mid-July that has triggered a wholesale run on commodities and an up-crash for the dollar. It’s been lightening fast and many investors, including hedge funds, are getting mauled.

It looks like the world economy is starting to deflate after a big post-2002 expansion. The forces of inflation and deflation are now fighting each other for the first time since 2001 and ultimately, inflation will win. If it doesn’t, you can kiss the banks, financial markets, housing and everything else that revolves around finance and credit into the gutter.

Central banks are aware of this, especially Bernanke, a devout Great Depression scholar.

For the Fed and other central banks the strategy is to rescue the global financial system from the economic abyss or deflation; that means they’ll print credit like there’s no tomorrow. The Fed, the European Central Bank, the Bank of Japan and their international buddies are going to accelerate the expansion of credit to avoid a devastating deflation. Inflation will triumph.

The next few months might continue to be painful for commodities. We are probably more than 50% of the way through this correction now with many commodities still in net supply deficit. Energy and gold mining stocks are also incredibly attractive at these bombed-out levels and should be aggressively accumulated. Also, the offshore oil drillers are down by a quarter since July and are still home to the best profits in the energy patch.

The world still needs oil, still has to drill for oil and gas and gold production won’t grow for at least another 24 months amid ongoing supply disruptions in South Africa and Australia.

Oil drilling, major oil producers and gold mining stocks are my favorite long-term growth themes within the resource complex and are incredible purchases right now.