2012: A Year to Accumulate Commodities

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 |  Includes: BHP, COPX, CU, JJC, KOL, SOIL
by: Disruptive Investor

In an economic and financial environment that is constantly bombarded with news (economic and financial news coupled with policy actions), it is difficult to assign price targets to specific asset classes. However, we can broadly guess the trend that specific asset classes might follow in the medium to long term.

This article specifically deals with the expected trend for industrial commodities in the medium term. I have expressed my bullish views on all commodities for the long term in previous articles. Therefore, with a medium-term expectation of sideways or downward trend for commodities, I consider 2012 to be a year for accumulating industrial commodities for the long term.

Discussed below are the reasons for being bearish in the near term and the commodities that I would accumulate for long term.

One of the most discussed concerns is the slowdown in China. There still might be debates on the extent of the slowdown. The Chinese business cycle index (according to National Bureau of Statistics of China) has declined to 101 in November 2011, from 113 in June 2011. Some sectors of the Chinese economy might witness a hard landing, while others might have relatively slower growth. However, in any case, there is no doubt that it will impact commodity demand and prices. Given the extent to which Chinese equity markets are discounting the slowdown, I am relatively sure that commodities will decline significantly in 2012.

The CRB commodity index has declined from levels of 370 in April 2011, to 310 currently. This is just a reflection of the waning demand for industrial commodities (in the near term).

Keeping the focus on the fastest growing economies, even India is expected to exhibit relatively slower growth in 2012. The demand for commodities is not very meaningful in India when compared with China. However, a slowdown will contribute to price decline for significant commodities.

Shifting focus to the developed world, the impact on commodity prices might come in the form of strengthening currency (specifically the dollar). It is a well known fact that a strong dollar is negative for asset classes such as equities and commodities.

The dollar index has risen from levels of 75 in October 2011, to over 81. I will not be surprised if the dollar gains in strength further in the foreseeable future. The eurozone crisis will keep the euro a relatively less favoured currency. Therefore, in times of relative risk aversion, the flight to the dollar will be significantly higher. With very muted growth (or even recession) expected in the eurozone coupled with continuous debt refinancing for various countries, the risk aversion in the system is expected to remain high.

Further, the United States might also need further policy action in 2012, in order to keep the economy going. As a general trend, the dollar does strengthen on any economic weakness before any policy action eases the liquidity tightening. Therefore, a relatively strong dollar for most of 2012 might keep commodity prices trending down.

With these factors in mind, I would certainly not consider 2012 to be good for commodities in any way. Factors, which might offset these concerns, would primarily be geopolitical tensions (especially for crude) and a significant amount of quantitative easing (both by the eurozone and the Fed). However, I would assign a much higher probability of downside than any upside.

Having said this, I maintain my long-term bullish view on all commodities. In line with this view, I would consider any meaningful correction in key commodities as a buy opportunity. Mentioned below are few industrial commodities (including crude), which I would accumulate in 2012.

Crude Oil – The long-term demand drivers for crude are intact. Any meaningful correction (20%-25%) is a good opportunity to consider long-term exposure to crude and few exploration companies.

Copper – The China economy weakening led price decline in copper is an excellent opportunity to add the commodity in a long-term portfolio. I can say with some conviction that the commodity holds potential to give multi-fold returns.

Coal – I am also bullish on the long-term prospects for coal. Coal consumption has shown robust growth in the past decade and the trend in expected to continue.

Some specific ETFs, which interest me (among the commodities mentioned above) are:

Global X Fertilizers/Potash ETF (NYSEARCA:SOIL) - This ETF is a good option to invest in the global potash industry with diversification across stocks and countries.

I discussed the fundamentals of copper in one of my earlier articles. I would stick to the same companies and ETFs, while considering exposure to copper. Some prominent names include Freeport-McMoRan Copper and Gold Inc. (NYSE:FCX) and BHP Bilton plc (NYSE:BHP). ETFs like JJC, CU and COPX can also be added to the long-term portfolio

Market Vectors-Coal ETF (NYSEARCA:KOL) is among the well known ETFs for investing in the coal industry. It tracks the index, which invests in global coal companies, including those engaged in coal transport, equipment manufacturing, and the production of clean coal.

In conclusion, one can expect a similar kind of volatility across asset classes, as witnessed in 2011. Therefore, short-term trading might prove to be damaging for the portfolio. One would do best by accumulating some hard assets for long term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.