The commodity market is currently in one of the biggest bull runs in history. Nearly every liquid commodity is moving rapidly to the upside. If you are not in these markets, you should highly consider getting involved immediately. The reality is missing a bull rally like this would be equivalent to missing the stock boom in the 1990’s. Over the past several years there have been a vast number of commodities that have surged in value. This year, several markets are at all time highs, and are continuing to trade higher. There is buzz among contrarians asking themselves, “How high can these markets go?” Gold recently hit an all time high record $967 an ounce, silver is trading at the highest price it has traded at since 1980. Crude oil is trading above $100 a barrel, and the soybean and wheat markets are also trading at all-time historical highs! The list can go on and on. I expect the commodity markets to continue to outperform the stock market well into 2009. In fact, the current Bull Run we are experiencing in commodities maybe prevalent for several more years because of all the fundamentals driving this market are not going away anytime soon.
Commodities Advocates
Recently, Goldman Sachs and Merrill Lynch & Co., two major equity companies, have become big time public advocates for commodities. Goldman Sachs said recently that they feel the commodities rally- especially for agricultural products- is likely to last another three years and appears to be recession proof. Jeffery Currie, the head of Goldman Sachs’ commodity research group stated, “We’re already in the longest sustained agricultural rally since the 1970’s. You have a robust demand story that is likely to remain strong even under economic duress.” Goldman Sachs also stated that soybeans should be one of the hottest bets currently, and they are expecting the market to have gains of 29% this year.” Not to be out done by Goldman, Merrill Lynch recently published enlightening remarks regarding the commodity markets. They stated, “Agricultural commodities and precious metals may gain in 2008 as demand from emerging economies surges and investors look for alternatives as the dollar and equities decline.” The primary emerging economies that they are referring to are the “BRIC” economies, which are comprised of Brazil, Russia, India and China. The enormous surges in growth of these economies have greatly increased the global demand for commodities all across the board.
For the last 25 years, Academic institutions have advocated through popular studies that investors should diversify their portfolios into commodities. One of the most popular studies regarding diversification is that of the Modern Portfolio Theory. Harry Markowitz first introduced the Modern Portfolio Theory with his paper titled “Portfolio Selection,” which was published in the 1952 Journal of Finance. Thirty-eight years later, he shared a Nobel Prize with Merton Miller and William Sharpe for what has become a broad theory for portfolio selection. Even though the original concept of Modern Portfolio Theory was originated some time ago, it has been revisited many times recently. Harvard professor Dr. John Litner revisited Modern Portfolio Theory in 1983 in a report titled "The Potential Role of Managed Commodity Financial Futures Accounts in Portfolios of Stocks and Bonds." Dr. Litner’s conclusion was: "Portfolios...including judicious investments... in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.” Today, a variety of academic evidence demonstrates the potential benefit of using futures to create a better balance to a stock and bond portfolio. In a study by Goldman Sachs covering a 25-year period, they concluded that "allocating only 10% of a securities portfolio to commodities, investors can vastly improve their performance." Another study by the Chicago Mercantile Exchange, one of the world's largest futures exchanges stated "Portfolios with as much as 20% of assets in managed futures yielded up to 50% more than a portfolio of stocks and bonds alone." This research demonstrated the acceptance of diversification of commodities into the common investment portfolio. Once thought to be “too risky,” now more than ever commodities are in the mainstream.
Fundamental Conditions
Current U.S. economic conditions are in a time of extreme uncertainty. The sub-prime mortgage crisis, poor economic conditions, a weak U.S. dollar, and an erratic stock market are all factors that are gearing more and more investors into commodities. There is a prominent fear of inflation currently in the U.S. and Federal Reserve Chairman Ben S. Bernanke signaled the U.S. central bank is prepared to lower interest rates again in March even amid signs of accelerating inflation. The Federal Reserve’s recent cuts in interest rates have sent the U.S. dollar tumbling, which has greatly enhanced the appeal of energy, grains and precious metals as a hedge against inflation. Investors are purchasing commodities to hedge against rising consumer prices. In addition, the falling dollar makes raw materials priced in U.S. currency cheaper for buyers holding other currencies. Most investors and analysts agree that the situation with the dollar will get worse before it gets better. The forces behind the dollar’s weakening have been building for years, but didn’t have much effect until recently. The weak dollar could continue to be a large contributor to the bullish trend in commodity markets for some time.
As mentioned earlier, another colossal contributor to the rise in commodity prices is the increasing demand on the BRIC economies. The BRIC economies are likely to become a larger force in the global economy much faster than most anticipate. What would such a high rate of growth mean for the rest of the world? It very well could indicate a global commodities price rise. With the rapid rate of growth of these countries, the supply must quickly meet the increasing global demand. One major example of this is the rapid expanse of China’s economy. The EPI notes, “At 6% to 8% growth rates in China’s economy, the country could reach US per capita income levels by 2030 to 2040. If this indeed happens, and Chinese consumption patterns approach those of us Americans, then the impact on commodities demand will be staggering.” Lester Brown of the EPI calculates that China alone could consume 2/3rds of the world’s current grain harvest, 4/5ths of current global meat production, 1.12 times the world’s current coal production, and 1.25 times of today’s global oil production. With the rapid rise of these economies keeping the demand for commodities at record levels, the bull run of higher commodity prices is likely to continue. Global commodities demand is growing relentlessly; yet global production capacity for most commodities cannot keep pace. Typically when we see demand growth increasing faster than supply growth, the inevitable response is higher prices!
During times of economic uncertainty in financial or international markets it is common for investors to participate in a flight to quality, which is when investors move their capital away from riskier investments in to the safest possible investment vehicles. Commodities are typically thought to be a safe haven for investors. With the stock market and economy in a slump, more and more investors are pulling funds out of “paper assets” such as stocks and re-allocating the capital into “tangible assets,” such as commodities.
The CRB Index
In 1934 the U.S. Department of the Treasury requested that the Bureau of Labor Statistics began the computation of a daily commodity price index. This index was released to the general public in 1940 and was known as the Commodity Research Bureau index, or the CRB index. This index is comprised of an assortment of 17 different commodities that should represent the general performance of the commodities market as a whole (similar to what the S&P 500 Index is for the stock market). With inflation fears, worldwide political uneasiness, and investors reallocating some assets from their diminishing stock portfolios, commodity investments are continuing to draw increased attention. The CRB Commodities Index is currently climbing with the rapid rise of commodity prices as more and more investors are allocating funds to commodities. The chart below (Figure 1.0) represents the steady climb of the CRB index in conjunction with the rise of commodity prices. We feel that the CRB, along with the commodities markets as a whole possess an enormous potential for growth.
Figure 1.0
Recommendation
Commodities are soaring, and the markets have the fundamentals behind them to help the rally continue for years to come. Within the past 6 months countless commodities markets have hit record levels and made new contract highs. The weak U.S. dollar coupled by an excessive demand for commodities worldwide should continue to push commodities higher. Jim Rogers, who predicted the commodities rally, expects the current Bull Run to possibly continue through 2014 to 2022. As more investors come to understand the potential power of the commodities as an investment, more and more capital will pour in to these markets. Everyone has his or her own individual risk tolerance and pocket book size. In the commodities markets you can leverage your funds appropriately, according to your individual situation. I highly recommend diversifying into these markets so you can capitalize on what might be the largest bull run in history.
The question that has been recently asked of me is, “Aren’t prices to high?” My simple answer is this, “Buying commodity options right now entails the same risk as when prices are at all time lows.”
Questions or Comments:
Christine London
Opportunities in Options
800-900-8000 x 210
www.OIOonline.com
Futures and Options involve risk of loss and may not be suitable for everyone.
