Why May's Market Gains Can Continue

This piece is from John Derrick our director of research and originally appeared in our Weekly Investor Alert.

The book is closed on May, and what a great month it was for commodities, precious metals and emerging markets. And there are several good reasons to believe that the strong performance will continue in June and beyond.

The price of oil rose nearly 30 percent in May to close above $66 a barrel. This was oil’s biggest monthly gain since March 1999, when it climbed more than 36 percent. Natural gas picked up 14 percent, reversing its negative trend so far in 2009.

Gold was up more than 10 percent in May, its best month since November, and is once again nudging close to the $1,000-per-ounce mark. Silver turned in its best monthly showing in more than two decades – the futures contract for July delivery rose 27 percent.

It was a good month for copper – up about 9 percent. It’s now up more than 57 percent year-to-date. The Reuters-Jeffries CRB Index, which measures a broad basket of hard and soft commodities, gained 14 percent in May, its best month since the summer of 1974.

In key emerging markets, India’s Sensex index increased 28 percent in the month, while Russia’s RTS index popped 22 percent. Double-digit gains were also seen in Brazil and Turkey, among others.

We have been seeing signs of improving health in the global economy for a few months now in terms of better-than-expected economic growth rates, industrial production, consumer confidence and other measures. The positive indicators prompted OPEC’s secretary general to say Friday that he expects oil prices to be as high as $75 a barrel by year-end.

But the primary driver for oil, gold and commodities is the weakening dollar, and there is little reason to think that the dollar will strengthen any time soon. The dollar hit a five-month low against major currencies on Friday.

Expectations of massive federal deficits for years to come – both to recover from the financial meltdown and to pay for President Obama’s ambitious social programs – will serve to undercut the dollar’s value. On top of that, economic growth is likely to be stronger abroad than in the United States.

The dollar’s precarious standing has contributed to fears of waning demand at future Treasury auctions. China, the largest U.S. creditor, has made it clear that it disapproves of Washington’s monetary expansion policies and that it has little appetite for adding to its huge holding of U.S. government debt.

Treasury officials held their breath going into a sale of $26 billion worth of seven-year notes on Thursday. That auction went off successfully, but the fear that buyers will stop showing up remains.

A failed Treasury auction could be catastrophic for the dollar.

The Federal Reserve would have to step in as the buyer of last resort – to do so, it would have to print new money, which would add to the downward pressure on the dollar, which would make dollar-denominated Treasury securities less attractive and harder to sell, which would force the Fed to print even more money to buy even more Treasuries, which would further hurt the dollar… you get the idea.

The second quarter usually sees seasonal weakness, but the first two months of the current quarter have defied that historical tendency. China usually sees a slowdown in the second quarter, but not this year.

One possible explanation is that after such a big overshoot to the downside in the two previous quarters, we are now seeing markets swing back toward a balance. If that’s the case, it’s one more reason to be thinking positive.

The Mumbai Stock Exchange Sensitive Index (Sensex) is a cap-weighted index. The selection of the index members has been made on the basis of liquidity, depth, and floating-stock-adjustment depth and industry representation. The Russian Trading Systems Index is a capitalization-weighted index that is calculated in USD. The index is comprised of stocks traded on the Russian Trading System. The Reuters/Jefferies CRB Index is an unweighted geometric average of commodity price levels relative to the base year average price.

Comments

[AndrewBaker:]

Sure we'll see higher prices in commodities, precious metals and emerging and eastern stock markets, and that is because the dollor is falling and will continue so to do. So the game right now is buy these securities, but keep a close watch. When the US market corrects steeply, as it must because it is up too much too soon on nothing, then watch those emerging markets come down fast too. Along with them will come base and industrial metals, 'cos there really is no call for their use at this time, and oil, for the same reason that stocks will be more than needs. What will continue on the up is precious metals gold and silver, and agricultural grains and other softs as demand will exceed supply; and in both these cases one has a hedge against the falling dollar.

I'm long gold, silver, agricultural softs, and oil at this time.

Jun 02 01:59 PM