Just recently, sentiment in the commodity market has turned positive. Capacity utilization improved, the CRB index started to move upwards, chances on QE3 are improving, and the dollar index moved into a top formation. In this article, I will discuss the prospects in each sector of the CRB index and point out how each part of the CRB index is showing signs of recovery.
On July 17, the capacity utilization rate came in at 78.9%, up from 78.7% the previous month. As I noted here, the capacity utilization rate is a leading indicator for inflation. This inflation will start to be visible next year, as there is a lag between the capacity utilization rate and commodity prices.
The most important part of the CRB index is petroleum. In July 2012, we witnessed the Iran oil embargo, which spiked oil prices from $US 80/barrel to $US 90/barrel. This certainly helped in moving the CRB index upwards, but the contribution of the oil price is only a third of the CRB index.
(click images to enlarge)
Almost half of the CRB index is comprised of agricultural commodities like soybeans, corn, and wheat (Figure 1). These agricultural commodities have skyrocketed due to supply disruptions.
Wheat has gone up 7% since the start of July 2012, while soybeans rose 13% and corn increased 22%. In this article, I gave an idea on how to profit from the rise in agriculture by investing in fertilizer companies like Allana Potash (ALLRF.PK).
Besides agriculture and petroleum, the metals sector composes 20% of the CRB index. Gold (GLD) and silver (SLV) have been bottoming out, however, the prospects in gold are improving on high Chinese demand. China has been increasing gold imports from Hong Kong for the last few months. With respect to silver, I previously made the case that silver would begin an updward trend. Copper should also move upward on hopes of quantitative easing. Copper is moving back into backwardation, as the red line in the chart below shows. As copper moves into backwardation, I expect prices to rise. One of the better copper miners is Capstone Mining, (CSFFF.PK) which I recommended in this article.
Chart 2: Copper contango/backwardation
The last important component of the CRB index is natural gas. Raymond James analyst James Rollyson predicts that natural gas prices (UNG) will bottom out this year and begin to recover, possibly reversing the previous shift toward natural gas. We already see this bottom occurring, as illustrated in the chart below. The coal sector is the catalyst behind the upward trend in natural gas prices. Low natural gas prices have forced coal plants to shut down, e.g. PJM Interconnection and MISO. This decline in coal energy production will be replaced by higher natural gas consumption, resulting in higher natural gas prices. I previously recommended that investors consider buying Gazprom to get into natural gas.
In the immediate future, we can expect QE3 from Bernanke, which I wrote about here. In the most recent Fed minutes from July 18, Ben Bernanke said: "there is capacity for further easing."
Goldman Sachs confirms the possibility of a large easing action at the end of 2013:
Our base-case expectation is for an extension of the rate guidance by September, with a larger easing action (asset purchases or a "credit easing" program) in December or early 2013.
This will debase the U.S. dollar, while commodities and the CRB index will start moving upward.
As the chart above shows, the dollar cash index is forming a top right now, and should be trending lower in the second half of 2012, if we look at a longer term chart. Based on the negative correlation between the U.S. dollar and commodity prices, I believe investors should take the opportunity to exchange some of their cash reserves for commodities. To accomplish this, I recommend investing in the iPath Dow Jones UBS Commodity Index (DJP).