The dynamics of today's commodity markets are especially interesting. As the secular stock bear market grinds forward, valuations are compressing. Meanwhile, vast numbers of people are finding a better life in emerging countries. The structure of energy markets has changed radically. World oil production has enjoyed an undulating plateau in supply levels for almost a decade while natural gas and coal are depressed. Developed nations find themselves debt laden.
The industrialization of China has long been a favorite investment theme. Invest in emerging markets by selling them what they need. This idea has been struggling with the iron ore collapse hurting producers like Cliffs Natural (CLF). Chinese copper demand growth being the lowest in fifteen years has copper producer Freeport-McMoRan (FCX) down 25% from 52 week highs.
Chinese government leadership is undergoing a change which may be delaying policy response. While the world waits and hopes for stimulus measures to be announced, little has been forthcoming. Investors may do well to be patient until the rate of China's growth re-accelerates to invest in the base metals and materials. As companies like BHP Billiton (BHP) delay and defer projects, Jim Rogers noted the development to be long term bullish.
The energy sector has the most moving parts. Natural prices are depressed, the rig count has moved sharply lower, and production has yet to fall meaningfully. Stubbornly high production has confounded natural gas bulls who have underestimated associated gas production, the backlog of wells to be worked off, and increases in well productivity.
The coal sector may be the best speculation on a meaningful rise in natural gas (UNG). I am patiently waiting for a possible entry point. Avoiding the leveraged and high cost industry participants will be vital. Peabody Energy (BTU) would be a natural industry leader, but Australian headwinds will hold Peabody back. If the time to invest in coal arrives, low cost Powder River Basin producer Cloud Peak Energy (CLD) looks to be my favorite.
Oil (USO) has more bullish fundamentals. Conventional oil production peaked in 2005 and the new higher price deck has spawned the unconventional oil revolution. With today's robust oil prices U.S. producers may slightly increase total world oil production, yet high pricing is required for new production to be economic.
Crude oil inventory is flush while refined products levels are tight. Enough oil is being produced, while the EIA notes spare capacity is quite small. Importantly, world oil consumption is not as highly levered to emerging nation growth as the industrial commodities.
Perhaps oil pricing will be range bound at a robust level. Oil prices above $100 a barrel causes growth problems, drives supply higher and encourages efficiency. Oil below $100 is defended by OPEC, sees dramatically lower shale oil rates of return and spurs demand. Despite the political rhetoric, the Straits of Hormuz are not going to be shut down.
Meanwhile, the developed world is deep in debt. Private sector U.S. GDP is surprisingly strong. The Federal Reserve is being watched for possible stimulative measures, yet Europe may be where the activity occurs first. If so, the chief beneficiary would not be economic growth, but gold (GLD) and silver (SLV). Western world stimulus is of the monetary variety, as opposed to developed world stimulus which would be infrastructure orientated.
Consider the possibility the precious metals will lead the commodity complex until China re-accelerates. Outperformance may continue through at least the remainder of 2012. My favorite play at the moment is Silver Wheaton (SLW).
Disclosure: I am long SLW.