Gold and Energy: Only a Temporary Correction

Includes: GLD, IAU, OIL, USO
by: Ron Haruni

When it comes to rising commodity prices oil has been grabbing most of the attention. But other commodities like copper, steel, and precious metals have surged as well over the past years.

True, the commodities market is not a new concept. It has been in existence for a long time and its bullish growth in recent years has made it a lucrative investment option. This was especially true during fiscal ‘07 where commodities accelerated their strong run.

Naturally, there has been no lack of theories and explanations as to why prices have soared.

A common alternative against the argument has been the weight of investment money driving prices higher. However, the continued uptrend in commodities, particularly energy and metals is primarily attributable to the developing world led by China and India.

China is going through a very metals-intensive phase of its industrial development which now accounts for 20%-30% of the world’s consumption of base metals. During fiscal ‘07 alone, precious metals were up 10% to 25% due mostly to tight supply-demand fundamentals.

Meanwhile, with gold now well below $1000, down 10 percent from its highs of $1,030.80 an ounce on March 17, and oil dipping briefly below the $100 p/b levels, investors are fleeing commodities on a view that perhaps gains are overdone. So what spooked the traders? Why the broad-based sell-off in commodities? Is this simply profit taking or something more significant that marks the end of the bull run?

Our guess is that it is only profit taking. All commodities suffer corrections from time to time, even in a bull market. However, there are some key factors contributing to the current correction. Starting with Fed’s .75 basis point cut on March 18, suggesting that Fed is going to rest for a while. Also, if gold were to start heading lower again, below $900 an ounce, that might create a temporary cycle of further selling. Additionally, the data released from different agencies measuring global trade activity is quite relevant as well. According to the latest reports: the annualized rate trade for the 3rd quarter of fiscal ‘07 grew at almost 7% against that of only 0.2% in the following quarter.

The number still suggests growth however, when compared with the 7% increase of the third quarter, the last reporting remains significantly weak.

Based on data it is very clear that we are seeing a slowdown in global trade activity thus the selloff on the last few days.

However, having said all this, if gold were to retreat $100 or more from current levels, as a reaction to prices nearing the $1,000 mark again, I would treat it as a buying opportunity. The pullbacks will eventually chase out the weak hands and the declines are likely to be only temporary retreats along the way to much higher prices down the road.

Today, virtually all opinion-makers think commodities are headed south over the long haul. Personally, I disagree with that assessment. If there is one thing with the highest probability in happening is that - in the coming years inflation will make quite a comeback, fueled in large part by energy and easy money. As a result, gold and energy stocks will post great returns.