Commodities Boom and Rotation

Last weekend's Barron's had a feature article on the commodities bubble. Don't get too scared by it. First of all, a cover article like this saying "bubble" usually means it is not a bubble yet, from a contrarian perspective. Secondly, a price increase itself doesn't necessarily indicate the status of a bubble, if the fundamentals support it, especially after a long period of very depressed prices. For example, the NASDAQ had a good run of several folds for 10 years after 1987 market crash, and it was still much lower in 1997 than today's price, even after the famous 2000 crash of the internet bubble. Also, in those 10 years, NASDAQ has gone through many sector rotations, from computer hardware to software, from telecom to internet.

At the end of the day, for commodities, it is always the supply and demand driving the price long term. The commitments of traders [COT] report is important for individual commodities, but more from short-term trading perspective due to the nature of speculation by traders. I agree some of them have too much hype and are due for correction, but to say the whole commodities sector is in a bubble stage based on a few individual COT reports is premature and has little predicative power.

I think what has been happening in the commodities market since early in the decade is sector and product rotation among commodities themselves. I am fully aware that it is always dangerous to say this time is different, but we have not seen this type of commodity rotation for a while. But at the same time, it is really not "this time is different", because this somewhat similar rotation happened in the 1970s too. In both periods, we see that oil, uranium and energy are leading the charge, then the solid commodities (metals) and soft ones (agricultural products) follow. When one or several of them get overbought, overheated and take a rest with corrections, a few others simply take over to lead the charge, so on and so forth. It is like tide waves one on top of another, eventually reaching a higher level for all.

Today when everyone is cheering about wheat and soybeans finally correcting, does anyone notice that rice and corn are actually at all time high? This commodity boom is actually more dangerous than in the 1970s when people were more focusing on energy and the monetary function of precious metals. Wheat is the common ingredient for almost all foods in the supermarket, and rice is everything for people living in Asia. There have been many indications that agricultural consumption continues to grow each year, and inventories remain at all time low, production remains flat or declining, similar to oil, energy and metal sectors, without even factoring in biofuel.

There are shortfalls in almost every commodity, whether solid or soft, black or white. With inventories low and demand high for all agricultural products, with competing acreage among them, the USDA's Prospective Plantings report becomes less meaningful than before. Due to the price drop in soybeans and the rise in corn recently, Farmers will probably change their minds by the time they plant anyway. When every essential element of our lives going up, such as food, there is really not much anyone can do, including governments which are trying to curb inflation, since there is no cheaper substitution hanging around anymore.

There are already many reports indicating that over 30 countries in the world are running short of food, and more and more governments are blocking any exports of agricultural products to ensure their own people get fed first. This is contagious, more governments will follow suit, making the food shortage a much bigger problem to solve on a global scale. Same thing on inflation. Thanks to fact the market is more global than in the 70s, inflation is also much more contagious than before.

This commodities rotation will also make people holding any type of commodity profitable, since commodities are taking their turns going up. As long as people don't chase the high-flying ones, use minimum leverage, have patience to sit and wait for the next turn on theirs, in a year or two or even sooner, their time will come.

Comments

[BrucePile]

If you look at a chart of the financial asset/hard asset cycle over the last 50 years, you see a pretty smooth cycle length of about 15 years. You can draw a historical mean through it which shows that oil is leading the charge in the new hard asset bull cycle that began in earnest about 4 years ago. The crops are lagging oil and gold and about everything else. Relative to the CPI inflation and to the financial/commodity cycle, they are just now breaking a very long decline, in fact, and the recent strong action is probably more akin to a very long base break than to a bubble.