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Published: November 3, 2009
Commodity prices have
faltered in the last couple of weeks, and much of the “smart
money” is saying the boom is over.
Don’t believe it.
As long as the world’s central banks keep interest rates at
these very low levels, the speculative interest in commodities
will be strong, and so will their prices. Since only minor
central banks yet show signs of moving rates, the commodities
bull market has further to run.
The commodities bull has already run a long way. Since Jan. 1,
gold is up +20%, silver is up +50%, copper is up +100%, oil is up
+110%, coal is up +90% and iron ore is up +60%. In a year of deep
recession -- with the exception of wimpy gold (which did not
decline as much in 2008, because all the monetary “stimulus”
made people fear inflation) -- that’s a pretty good run.
The Key Catalysts
There are three reasons why commodity prices have been rising,
and they’re all still true:
- China and India continue their torrid growth.
- Global stimulus plans are bullish for commodity prices
- And hedge funds and other speculative investors are big
commodities players.
Let’s examine each of these in more detail.
1. The “China Syndrome”: While the rest of the world has been
mired in recession, China has had a pretty good year, and so has
India. China’s third-quarter gross domestic product (GDP) rose +9.5% from the same period last year, and India is expected to
post an increase of at least +6%.
That has caused demand for raw materials to soar, because
lifting the 2.5 billion inhabitants of those countries out of
poverty generally requires lots of goods you can drop on your
foot.
For instance, China leapfrogged the United States this year to
become the world’s largest automobile market, with sales of 11
million cars and light trucks. China and India show no sign of
dropping back into recession. If anything, demand growth in
those two countries is likely to continue, which in turn will
put additional pressure on global raw materials supplies.
In general, we have plenty of commodities, but opening up new
production takes lots of time and money, so rapid demand growth
pushes up prices.
2. Money Talks: Stimulative global monetary policies have tended
to push up the prices of all assets -- but most notably
commodities -- in the last year. Those monetary policies aren’t
just a U.S. manifestation. Japan has interest rates close to
zero and has engaged in lots of “quantitative easing.” Britain
has had even laxer monetary policies than the United States,
with the Bank of England buying more than $300 billion of
British government “gilts.” And China’s M3 money supply grew +28%
in the last twelve months.
Monetary policy would have to get quite a lot tighter -- with
interest rates higher than the inflation rate -- before it
started choking off commodity prices, and there’s not much
evidence of that. Yes, Australia and Norway both raised their
base rates by a quarter percentage point in the past two weeks,
but both countries are special cases, being commodity producers
themselves (Norway produces oil, while Australia produces pretty
much everything).
Maybe China is beginning to tighten a little, too. However, the
other big boys aren’t. U.S. Federal Reserve Chairman Ben S.
Bernanke has said rate increases are a long way off. Britain’s
GDP was still falling in the third quarter, so that country
won’t be tightening soon. And most of the Eurozone (Spain,
Ireland and Greece, in particular) is suffering from huge real
estate meltdowns, while other exporting countries worry that the
euro is becoming too strong against the dollar -- so euro rates
won’t rise fast, either.
The bottom line here: Without higher interest rates, the
commodity boom will continue.
3. Investors “Get Physical”: Hedge funds and other speculative
investors are piling into commodities. What’s more, as I
mentioned a couple of weeks ago, they aren’t just buying
commodities futures; in many cases, the hedge funds are buying
the physical commodities. Since the supply of most commodities
is a small fraction of the volume of hedge funds outstanding,
prices could shift quite sharply as supply disruptions occur.
Until China and India stop growing or world monetary policy
tightens a lot, any blips in the commodities market are just
that -- blips.
Ways to Play the “Bubble”
There are a number of ways to play a commodities bubble. It’s
probably smart not to restrict your buying to gold and oil
alone, but to spread yourself among a number of sectors. Let’s
take a look at some of the better plays right now available.
They include the:
- Powershares DB Base Metals ETF (NYSE: DBB): This
exchange-traded fund tracks the Deutsche Bank AG (NYSE: DB) base
metals index, thereby allowing you to invest directly in the
price movements of non-precious metals. With a market
capitalization of $387 million, this ETF is at least reasonably
liquid and money has been flowing into it recently.
- Vale SA (NYSE ADR: VALE): Brazil’s largest iron ore producer,
and a key supplier to China’s exuberant infrastructure growth,
Vale is a true play on the global commodities market. With a
historical Price/Earnings (P/E) ratio of about 15, Vale will
benefit hugely from further run-ups in the price of steel.
- iShares Silver Trust (Amex: SLV): This fund invests directly
in silver bullion, which has been left behind somewhat in its
relationship to gold’s price rise -- and which can be expected to
move up as gold does, possibly by an even greater percentage.
- Market Vectors Gold Miners ETF (NYSE: GDX): Gold miners
benefit disproportionately from a rise in the price of gold
because their production costs are fixed. This means that miners
are a more leveraged way to play gold than the metal itself,
particularly as surging speculative demand can increase mining
companies’ P/E ratios.
- Market Vectors Coal ETF (NYSE: KOL): China’s power supply is
still coal-fired, and demand is soaring, hence global coal
prices are likely to be pulled upwards by Chinese demand alone. KOL has a market capitalization of $283 million.
-- Martin Hutchinson
Contributing Editor
Money
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