Still Believing in Commodities

In this weekend's Barron's magazine article Commodities: Who's Behind the Boom? (subscription required), Gene Epstein provides a compelling argument that the commodities bubble is, indeed, a bubble and that it is about to burst. And the price action in today's markets certainly seems to support that thesis. All that said, I disagree.

In his book Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market, Jim Rogers indicated that during commodity bull markets, there are periodic corrections that are sometimes severe. I believe we are simply experiencing a pullback, nothing more.

If you look at the graphs of the commodities indexes on Bloomberg's website, you will note that, while commodities have become more volatile recently, they are still up on the year. Oil prices remain near record highs, natural gas is strong, along with agricultural products. If you visit Kitco's five year gold chart or Kitco's five year silver chart, you will again note that prices are still up substantially compared to recent history.

In the Barron's article, we are told that it is speculation that is driving commodities far beyond reasonable valuations. My response is that if prices are so far beyond reasonable valuations, why are the physical producers not taking advantage of this situation by dramatically increasing their production? The answer is, of course, because they cannot do so. They simply do not have the ability to find more readily available cheap oil. Finding gold and silver are similarly difficult. Natural gas is somewhat different because a lot of previously stranded natural gas is being converted to liquid natural gas [LNG] and imported to the U.S. I do not follow farm products, so I am more cautious about my comments. From my weak knowledge of the ethanol boondoggle, some artificial forces are creating a distortion. The point is, many commodities remain in short supply and are difficult to produce more quickly.

Until I see the commodity suppliers threaten and have the ability to carry out their threat of substantially more production, I will remain steadfast in my outlook. At present, I do not see significant additional sources of production coming on stream. Does that mean that prices can grow to the sky? The answer is clearly no. Prices are constrained by customers' ability to pay. While some argue that the U.S. recession is now removing the customers' ability to pay, I am in the camp that says world growth is still growing and thus commodities are still in demand.

In summary, while I acknowledge that the commodities markets are volatile, I continue to believe that the bull markets in commodities will continue. And while the U.S. recession might temporarily damp the price of commodities, I expect that external demand to be a moderating force. The demand for commodities continues to grow and the ability to produce more commodities cheaply is not keeping pace with the increased demand.

Comments

[leh:]

I agree Kevin. Way too much use of the word "bubble" here in the media, especially on CNBC. I hate the sloppy sensationalism that is being broadcast here as it's bound to confuse the public and possibly keep them from investing in this market long-term. Barron's piece may have been a decent ST trading call but the time windows should have been made clearer.

Also, how about calling this commodity surge something more precise, such as an emerging and powerful global bull market based on simple supply and demand dynamics? I note that even with the recent sharp correction in gold--something most savvy observers predicted several weeks ahead of time--oil remains relatively strong and many gas and oil drillers/explorers are hitting new highs as I write this. IMO crude remains the 800-lb gorilla in this room, and for good reason: it's the very lifeblood of commerce and industrial development.

I'm a buyer of gold around $800 and agree with Jim Rogers that we're still in the early innings of this commodities bull given the emerging global demands, which will only multiply over the next decade. It will be interesting to see if gold rallies after this current bear market equities rally peters out and traders rotate once again to safer havens.

2008 Apr 02 12:23 PM

[Mark Anthony:]

Gene Epstein's so called commodity bubble theory is not worth the paper on which it is printed. Not long he did not present any compelling argument, but he was logically inconsistent and wrong.

This is an article that completely debunks Gene Epstein. Enjoy:

seekingalpha.com/artic...

After you read it, please leave your comments.

2008 Apr 02 05:29 PM