The Commodity Bull Is Not Lame

Includes: OIL
by: Wall Street Strategies

By Conley Turner

After a brief respite in the last six weeks, crude oil, along with other commodities, regained their footing after declining by approximately 5 percent since April 29. The move down was precipitated by resurgent concerns regarding the debt crisis in Europe. Investors lost their appetite for risk and as a result exited most asset classes. This flight from risk dragged down even the S& P 500 (NYSEARCA:SPY) by 3.2 percent from the highest level that the index had seen in about three years. However, flash forward to present day and a recovery appears to be on the way.

The recent rally in commodities was precipitated by the Federal Reserve's announcement in September of 2010 of its program of quantitative easing. That program injected liquidity into the economy and was the catalyst for higher asset prices. However, when the central bank announced that the program was scheduled to end on June 30, market participants opted to lock in the gains of these assets. Since the market has a tendency to overshoot in both directions, the selloff appeared to be overdone and a shift in sentiment is in effect.

This outlook is underscored by the fact that a number of investment banks released a more optimistic revision for oil prices. Goldman Sachs raised its crude forecasts on concern that the shutdown of Libyan output will likely cause a drain on spare supplies out of OPEC. The company anticipated that the West Texas Intermediate Benchmark would hit $135 per barrel by the end of 2012. Another institution, Morgan Stanley, shared a similar prediction when it forecasted that Brent crude would average $120 per barrel in 2011. The energy markets responded favorably to the bullish prediction and this caused oil to stay above the $100 per barrel level.

Also providing buoyancy for oil is the fact that the Dollar Index continues to slip against a basket of six other currencies, thereby prompting investors to pile into the commodity. A declining dollar makes crude oil and other commodities less expensive for investors holding different currencies.

As it stands, the pace of economic growth is still weak as demonstrated by the most recent government report on the current situation. The Commerce Department indicated that the U.S. economy expanded at a 1.8 percent annual rate in the first three months of this year while the expectation by the market was for a 2.2 percent increase. What this suggests is that the recovery has lost some traction. As such, there is the strong likelihood that there will be the resumption of some level of quantitative easing and this should further impact the value of the dollar.

The fact of the matter is that the global economic recovery has not faltered and emerging markets led by China will likely continue to have a huge appetite for energy. As such, the recent decline in commodity prices is not likely to become a sustained trend.