Surprise! Commodities Can Go Down as Well as Up

A lot commodities got pasted Tuesday but you probably know that by now.

iPath Nickel (JJN) down 2.96%, iShares Silver (SLV) down 2.69%, PowerShares Base Metals (DBB) down 2.39%, Barclay's iPath Ag (DJP) down 2.08%, PowerShares Ag (DBA) down 2.61% and a lot of the related stocks were down too.

One bad day obviously means nothing in the long term but the upward price action that we have seen of late, the this time is different mentality, the awareness of the space by people who 12 months ago never had exposure and the intense media attention, are all a rerun of the same movie.

To address one thing up front, this time might actually be different. It makes sense to me that the supply and demand equation, especially for industrial and agricultural materials, is evolving, and that the types of prices we saw a year or two ago will never come back. Parabolic price rises though, especially throughout an entire segment of the market, are a sign of excess, and a big drop should not be a shock even if it is now different.

Let me also clarify: Most clients have exposure to gold, a seed stock, a diversified miner, and economies that benefit from the commodity boom, and one or two folks own DBA. Sentiment-wise, I am as on board as anyone, but I have also disclosed shaving down positions in a couple of names as they have run up. I would also suggest that you take inventory of what your exposure is, and think about the consequence to your portfolio if there is a nasty correction.

If you truly believe that this time it's different, and we really are just a few years into a two-decade run, then you have to understand that even if the ultimate run exceeds your wildest expectations, it cannot be in a straight line. During the emerging market boom, we have seen a handful of 25% corrections and there will probably be more.

I am not making any sort of prediction in this post nor am I doing any analysis. The point is to understand market behavior and what sentiment can do to prices on the way up and on the way down. The fundamentals of commodities could be unlike any other part of the market, but the behavior of people placing buy orders is not.