Monday, April 19, 2010

Commodities continue to boom


The amazing action in the commodities markets continues. This measure of raw industrial commodity prices is only 2.6% below its all-time high, and looks set to break new ground soon. The commodities that make up this index are not the sort of commodities that lend themselves to massive speculative activity, so I think the price action here mostly reflects strong global demand. Demand can be influenced by monetary policy, of course, because easy money tends to boost people's desire to own tangible things, and these commodities are the raw materials for a lot of "tangible thing" production. Easy money + strong global growth = strongly rising commodity prices.

The message to investors: the action in the commodity markets is a strong sign that deflation risk is minimal, if nonexistent. Yet the Fed and many market participants continue to fear deflation: that is one reason why the Fed has kept interest rates at zero for a year and a half, and it helps explain why Treasury yields are still extremely low from an historical perspective. I think the market is over-estimating the potential for downside risk, and that means there is still plenty of upside in equities. Full disclosure: I am long equities, TIPS, corporate debt, and emerging market debt at the time of this writing.

10 comments:

John said...

My favorite commodity equity remains Australian miner BHP Billiton. It is pulling back today with the group as money comes out of cyclicals. I would like to nibble on further weakness. Vale is also pulling back and I am beginning to circle Potash of Saskatchawan (POT) on its weakness. All of these are international commodity producers and IMO are relevant to Scott's post.

Discclosure: of stocks mentioned I am long BHP

John said...

There is one thing that keeps nagging me about the commodities. I continue to read that there is an awful lot of construction going on in China and the Gov't there is trying to cool it down. If they overdo it a lot of the demand we are seeing for commodities will go away quickly. That said, however, it is still the lower probability development IMO. I continue to be long BHP and looking to add on more weakness.

puffer said...

What is the best way to play a rise in the price of nat gas? I understand there are some problems with UNG?

Benjamin said...

John-

Finally! I am hearing a traditional American investor (you)thinking globally.
I am joking of course, I am sure you are a circumspect and insightful investor.

But, at times, when I read this or that commentary about commodities, and that it is the Fed causing commodity prices to surge, I feel like I am back in the 1960s again.

The biggest consumer of many commodities, including oil and iron and steel, is China. China has a huge fiscal stimulus program in place emphasizing infrastructure, and is expanding its money supply at a 22 percent annual rate.
China's GDP is expanding at an 11 percent annual rate.

Of course, China has a bigger influence now on commodities than the USA. They are a bigger buyer.

And the yuan is pegged to the dollar. If the price rises in yuan (likely, due to intense demand and expnded supply of yuan) the price in dollars gets dragged up.

We are a smaller actor in the commodities playing field. Moreover, while China's economy is growing at an 11 percent rate, and ours is still sluggish. Their total GDP should eclipse ours in about 10 years, maybe less. They are the world manufacturing platform, and are building out infrastructure and property. All that takes commodities.

Jeez, of course, China is the big reason commodities prices are rising. Oil demand from Europe and the USA has been flat to down for decades.

Asia is in a secular boom--demand for commodities will only go up from Asia for decades.

Benjamin said...

This is from the WSJ, on Jan. 21, but still informative.

By TOM SELLEN
Commodities futures were down almost across the board Wednesday as China's latest efforts to rein in economic growth sparked concerns about demand.

Investors were fleeing commodities for the safety of the U.S. dollar as the Bank of China ordered its credit officials to stop making new yuan-denominated loans. The news, coming after other recent measures in China, heightened concerns that interest-rate increases could happen sooner than expected.
Market participants fear tighter monetary policy in China could thwart a global economic recovery, and thus stifle demand for commodities ranging from copper and crude oil to corn and soybeans. Demand from China has been instrumental in supporting many commodities.

The Dow Jones-UBS Commodity Index was down 1.6% on the rampant selling. The ICE Dollar Index, which tracks the greenback against a trade-weighted basket of currencies, was up 1%.


last note: I see no mention of M2 or the Fed in this story.

John said...

Puffer,

Again, I am not trying to speak for Scott here and I am sure he has good ideas concerning your question.

If you wish to use an equity (stock) vehicle that will perform given a rise in the price of natty gas, take a look at FCG, an exchange traded fund comprised of smallish natural gas producing companies. I DO NOT own this and am not sure of the specific companies that are in it but I have seen it recommended by people I consider knowledgeable. Do your OWN homework before investing in this if you think it is appealing.

Benj,

I have actually owned a small position in BHP for some time and have a nice gain in it. But thank you for your kind compliment.

Incidently, since my last post above, I did nibble VERY SMALL at BHP - sort of a chicken sh-- buy, but hey. I believe in the dollar-cost-average theory. It has served me well over the years. We will see. I still like the story, and both you and Scott are bullish on Asia and commodities respectively.

puffer said...

Thanks for the idea John.

John said...

Puf,

You are welcome, sir.

Benjamin said...

John-

My overall feeling on investing is that you have to stay invested to win. How you invest--well, we can debate forever about that.

But to win, you have to in. And you are in. So am I. Let's hope for the best!

John said...

Amen, brother!!