Many commodity prices have dropped sharply in the past few weeks. The main excuse: The dollar has rallied off its lows.
Call it a bloodletting. In the Middle Ages, people believed bloodletting made a body stronger, but that’s certainly not the case today. Is this an opportunity to pick up some cheap commodities, or has the commodity bubble burst?
There were, of course, exceptions to this general commodity weakness. Last Monday, crude oil surged above $120 per barrel for the first time, and copper hit an all-time high price of $4.27 per pound in the morning. (By the end of the week, it was back below $4.)
Perhaps it’s no coincidence that these two are strongest. After all, they’re both major Chinese imports. Oil hit yet another all-time high May 6, nearly $123 per barrel. Despite a bearish inventory report, oil hit yet another all-time high May 7, at nearly $124 per barrel. Then, May 8, oil hit a new high at $124.61 per barrel. Like a broken record, oil topped that record, hitting above $126 per barrel and closing at a new record high May 9.
The common belief is that the Federal Reserve has finished cutting interest rates. Therefore, the dollar is through declining, and commodities will fall as a result. Although a weak dollar will tend to increase commodity prices in general, what this logic fails to address is the core supply/demand fundamentals of specific commodities, regardless of where the dollar sits.
The crux of this issue has to do with the emerging markets. Do you believe China and India are headed back down simply because the dollar strengthens? Their population growth alone places a floor on oil prices during corrections.
Consider this: In America, we have about 900 cars for every 1,000 people. By comparison, only 45 people per 1,000 own cars in China. Think about what would happen to oil demand if ownership in China merely doubled to 90 vehicles per 1,000. And China has recently surpassed the US as the biggest world consumer of copper, accounting for 27 percent of the world’s total demand.
But oil demand could certainly drop because of sticker shock and a slowing economy. On the other hand, food demand is relatively inelastic with the world population rate rising by 80 million people annually. To put that number in perspective, population growth is equivalent to adding the current population of Mexico to the world each year.
Here’s the punchline: Our position favors buying corrections in certain lagging commodities, specifically cotton and gold.
Today’s markets are interconnected. Hot money moves in and out of gold; the dollar versus the euro and Japanese yen; commodities; and bonds and equities, depending on which area looks cheap and which seems expensive. Over the past decade, and perhaps for the first time in modern history, commodities have become a respected, major asset class.
The trick in finding which commodities are worth owning and which you should shy away from lies in the underlying fundamentals of supply and demand. If the dollar breaks hard, the theory that the rising commodity tide floats all ships higher comes into play. However, when the dollar strengthens, there will still be individual commodities rising as long as there’s a compelling story behind it.
Let’s start with a quick word about rice, which lead our last Commodities Trends issue two weeks ago when it was trading at all-time highs.
Rice was in the limelight this past week. Costco and Sam’s Club limited the amount of rice customers could buy because of the irrational exuberance of its rice customers. The rice chart below (this is a fairly thin market that’s not too actively traded in the futures) looks like an accelerated rocket ride to the moon. Historically, these kinds of moves always seem to end poorly.
Although it may not be over yet, that rally didn’t end well. Here’s the current rice chart.
Just as the bullish story hit the media, the rice market traded at all-time highs. Then it proceeded on a severe 20 percent correction.
It’s coming back as we go to press, but here’s a proven trading rule of thumb: When the bullish news hits the media, it’s time to sell. The reason behind this is that all the bullish news is most likely already discounted in the marketplace, and common wisdom isn’t wisdom that will enrich you.
My job for Futures Market Forecaster subscribers is to find the trades in markets that haven’t hit the news yet.
In that spirit, here are two that have recently corrected into what appear to be value areas.
Gold--From January to March, gold prices surged by 25 percent to hit all-time high levels above $1,000 an ounce. From March to the first week in May, gold gave back all those gains.
Have the economic uncertainties that prompted investors to buy gold disappeared? I don’t think so. In the longer term, investors buy up gold for safe-haven reasons and as a hedge against inflation. And that trend is set to continue. In the short run, in relation to all-time high oil prices, the price action has been lackluster. I’d like to see some sign of momentum strength to buy in once again. One clue would be a close above the 50-day moving average (green line on the chart), currently at $910 for the June contract.
Cotton--In 2006, US cotton farmers harvested 12.4 million acres. Because competing crops such as wheat have been more profitable, this number sank to 10.2 million acres last year. This year, that number is lower still. About 9.5 million acres were planted, and even less will be harvested. As a result, our ending supplies of cotton are projected to fall by 45 percent by the end of this crop year.
Cotton appears cheap in relation to other commodities, but it’s more costly than ever to produce, and future supplies will shrink. The market is now close to breaking above its 50-day average again, which is currently just above 81 cents per pound. Keep an eye on it.
If you haven’t already, consider commodities for your portfolio. I wish you good trading.