Since bottoming in the fourth quarter of 2001. It’s clear that the commodity boom is in full swing...
In fact, some commodity indexes recently hit all time highs in October 2004, including the Rogers Raw Materials Index and the Goldman Sachs Commodity Index (GSCI).
But a healthy correction is now underway, and has been since November for most commodities — especially energy, the grains and the metals. Corrections in a bull market are perfectly normal.
They’ve occurred on numerous occasions for stocks throughout the 1980s and 1990s, real estate, bonds, currencies, art and, of course, commodities. Commodities typically have enjoyed bull market rallies lasting at least eight years and up to 15 years — the current bull market is now three years old.
Four reasons why commodities will continue to gain, in the long-term...
Commodities remain in a secular bull market for four powerful reasons:
- First, there’s a shortage in supply. Supply and demand determine the outcome for all asset classes. The fact is that since 1990, commodities have been falling, delaying the construction of new mines, drilling rigs or oil exploration facilities. Few companies spend capital on new capacity when the underlying commodity is declining. That’s why we’ve seen barely any new mines or drilling rigs in the world over the last 10 years — until now. You can’t just flick a switch to turn on a lead mine. It takes years to build new capacity.
- The demand factor is now well documented, mainly because of the rising appetite for raw materials in the emerging markets of China and India. China is consuming record amounts of oil, gas, coal, nickel, lead, tin, aluminium — you name it. Severe deficits already exist for several commodities in 2005, including tin, aluminium, titanium, steel-scrap and ready-mix cement. When you have booming demand, the ingredients for a massive bull market are in place, provided supplies are tight. That’s exactly the case now for about half of the commodities complex.
- Low global interest rates feed the commodity bull market. Despite raising interest rates in 2004, the United States would have to really aggressively raise rates to derail the bull market in hard assets — unlikely, considering the extent of mortgage-backed debt tied to housing.
Rates might rise further in 2005, but not enough to kill commodities. Historically, low interest rates have been one of the primary tonics feeding commodities. Surging rates, such as occurred back in 1980-81, would destroy the bull market. - The secular US dollar bear market is another factor supporting commodity prices. Historically, a falling dollar encourages money to flow into hard assets, like gold, silver and real estate, as inflationary fears rise and purchasing power declines. This is what has occurred since the dollar peaked in January 2002. A falling American dollar acts as a catalyst for rising commodities prices
Because investors and traders alike seek alternative hedges to protect their purchasing power, the correlation between the dollar and commodities is historically very negative.
The four compelling bull market mega-trends for commodities above will not dissipate any time soon. The ongoing correction for commodities since November 2004 provides an excellent buying opportunity for natural resource stocks and commodities futures now.
Energy is where all the best action is to be had
The best commodity sector now is the energy complex. This is where investors will plant very profitable seeds for the next round of profits in 2005. Since posting an intermittent peak of $55.17 a barrel in late October 2004, West Texas crude oil has plunged 24%.
Accompanying crude’s 34% rise last year were hedge funds and other traders, driving oil prices sharply higher in just a few months. A correction was inevitable. Though oil, gas, heating oil and coal prices should be trading at much higher levels today based on incredibly bullish demand fundamentals, the huge increase we saw last year was manic.
Corrections are normal, and this latest round of declines is mostly due to speculators shorting crude. Oil prices will rise this year because supplies remain extremely tight, geopolitical risks are high and terrorists in the Middle East will continue to target Saudi Arabian and Iraqi oil supplies.
Plus, China, though moderately slowing from 9% GDP in 2004 to about 7-8% in 2005, will still consume record imports of oil. In addition to these bullish factors for oil, a bear market rally for the US dollar will not adversely impact the energy complex. Unlike other commodities, which will take a hit if the dollar embarks on a bear market rally, the energy complex provides the lowest degree of dollar correlation.
The rally in crude, starting from the all-time lows in late 1998 through 2001, were in the context of a major US dollar bull market. I don’t expect oil prices to decline at all, should the dollar rally; but I do expect most other commodities to correct.
ERIC N. ROSEMAN
