'Big Fall' in Commodities? Not So Fast

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Includes: DBC, DBO, GSG, OIL, USO
by: Bob Zieger

The massive run up in commodity prices followed by last week’s sudden sell off has everyone wondering … are commodities the next bubble to burst? In fact, typically cool headed coverage in journals like the Financial Times warned of a looming “big fall” in commodities. But let’s not get too far ahead of ourselves here.

Relatively high prices for commodities - or at the very least oil and the other commodities it impacts - are here to stay for quite some time.

As the US economy stutters and the Fed lowers interest rates to provide a spark, the dollar gets even weaker. And since crude oil is traded as a hedge against the dollar, oil prices will remain high. There’s also quite a bit of evidence that shows the recent run up in oil prices (and even other commodities) is not exclusively linked with demand. So even if China’s consumption slows, that will have less of an impact on crude prices than the pressures from low interest rates and a weak dollar.

And as we know, oil prices have broad reaching impacts on other commodities. Food prices will remain high as long as oil prices are steep. Why (besides the obvious transportation costs)? Biofuels. With crude prices so high, everyone looks to biofuels for a solution, but what happens then? Crops are used to fuel vehicles with ethanol, not feed people and livestock. These demand streams compete for crop space and result in sustained high prices throughout the food chain.

Until these links are broken - which won’t happen anytime soon - the likelihood of a commodity nosedive is very slim. Sure there will be profit taking days, like last Thursday, for traders along the way. But most commodities will likely hit a soft landing later in the year if there is a sustained recession. There are too many interconnected links holding these prices up to have them all come crashing down quickly.