The MarketWatch Tell: Turning Contrarian on Commodities and Metals (ETFs: DBC, GLD, IAU, SLV)

Includes: DBC, GLD, IAU, SLV
by: Roger Nusbaum

Roger Nusbaum submits: If you still read Marketwatch you know that on the first of the month the site rolls out its Trading Strategies page with content about the market for the coming month.

Of the eleven features this month, five of them are about commodities (one way or another). Is this a sign of a top? Should anyone investing in this part of the market be concerned? The short answer is yes, you probably should be concerned.

I just submitted an article to RealMoney about portfolios with too much emerging market exposure. Chances are the same could be said about investors having too much in commodity related products too.

This post is more about risk management than analysis to say commodities will fall. I am likely to agree with any comments posted that make a bullish case, but the risk is what it is. Commodities tend to be volatile -- of course, over the last couple of years all of the volatility has been to the upside.

Commodity ETFs, funds and stocks are not immune to price cycles. I would expect any move down, be it short lived or not, to potentially be quite aggressive. Most clients have 2-3% in GLD and 2-3% in Plum Creek Timber, some clients have 2% in CVRD and that's it (note that I differentiate energy from materials). Clients also have exposure to countries that benefit from commodities, but the holdings themselves are not commodity plays.

The damage that could be done in a meltdown will be what it will be but I think the total drag in a worst case scenario would be around 5% of the portfolio. I categorize that number well within the realm of 'down a little'.

I would bet that many people have 20-30% in second and third tier names that, based on their moves up, could easily fall by more than 50%. This kind of portfolio drag moves into the realm of 'down a lot'.

If you own too many second tier names I would suggest reducing exposure now. Again, I am no less bullish on the theme -- this is about risk management.

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