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Tuesday, September 23, 2008 - Vol. 10, No. 227
Today's comment is by Eric Roseman, Investment Director and editor of Commodity Trend Alert.
Since July, commodity bulls have been trampled during the worst credit crisis in history. The entire complex has gone from being extremely overbought in June to heavily oversold in late September.
In just 30 days, the markets have violently transitioned from concerns about inflation to a sudden panic over deflation. The credit crunch has stopped inter-bank lending and corporate borrowing, leading us to the worst panic in American capitalism since the 1930s.
It's also resulted in the most indiscriminate commodity sell-off since the bull market began in late 2001. And 2008 might be the first year since 2001 that commodity benchmarks finish in negative territory.
And until the deflation (i.e. the environment of rapidly declining prices) ceases, commodities will remain vulnerable. Never in the history of capitalism have commodity prices rallied during a severe contraction in bank credit.
But even during this wreckage, I'm setting up my next big play. Before I tell you about it, we'll take a look at the economy as a whole and hopefully you'll see the pattern I'm talking about. You'll see that these losses aren't disastrous. On the contrary, they're the bellwether of a great buying opportunity...if you know where to look.
Playing Both Sides of the Commodity Bull
If you believe, like I do, that inflation is still very much embedded in the financial system then you must also adhere to hard assets, including gold. There's absolutely no doubt in my mind that we'll see much higher inflation as a result of this extravagant spending.
In my Commodity Trend Alert (CTA) service, we've recently raised our hedges against commodities. I anticipate tough markets for most of the sector until clearer signs emerge that the Fed has arrested deflation.
Still, I'm buying distressed oil companies and oil equipment stocks - and I'm buying oil right along side some of the best positioned global insiders. The energy sector remains the only segment of the marketplace heavily accompanied by net insider buying since prices began dropping in July.
Gold, which FDR confiscated in 1933, would probably rally in a deflationary economy. We got a taste of the huge gold rally to come when gold jumped over a US$100 last week after the AIG rescue.
Also, gold stocks haven't been this cheap and bombed-out since 2005. In fact, the mining stocks trade at a seven-year low versus physical gold! You should be aggressively buying up this sector now.
Commodity Hayride Hearkens Past Lessons
Investors tend to forget that commodities are an extremely volatile asset class.
Price swings have always been violent and the recent surge lasting through July drew a huge amount of fast money from hedge funds and other institutions - which are all liquidating as I write this. Bank failures and bailouts have also pressured prices as liquidity-starved institutions make a run for hard cash.
But you must remember that commodities plunged in value in the mid-1970s en route to incredible all-time highs by January 1980. That's happening again in 2008.
The CRB Index surged to an all-time high of 226.80 in September 1974 - at the height of the inflation squeeze, banking crisis and Arab oil embargo - and then commodities crashed to a new low of 175.90 by February 1975, a 22% plunge.
Gold prices, which Nixon set free in August 1971, soared to a high of US$184 an ounce in December 1974 based on the London monthly close. Prices then crashed all the way down to US$109 an ounce by August 1976. That's a dizzying 41% drop.
Commodities can suffer a major bull market reversal, and that can make new investors nervous. Honestly, it wouldn't be a surprise if commodities posted a negative year in 2008 after seven spectacular years of consecutive profits.
It is actually a positive development to see speculative money exiting the asset class because it takes policymakers' attention away from high prices. Case in point: Earlier this summer Congress held special hearings to voice their concern over oil price manipulation. Now that prices are falling, Congress will once again turn a blind eye to the next run-up in the prices.
Credit Crisis Is Our Problem - Not Asia's
As the United States, Europe, Japan and China all work to reflate the global financial system, the price of commodities will recover. The global economy will not suffer a hard economic recession. In fact, the emerging markets might escape one altogether.
Meanwhile, interest rates are still in negative territory if you adjust for inflation, and the Fed isn't likely to raise rates anytime soon. That's not about to change until both the housing and credit markets heal.
Inflation is not dead and commodities remain in a secular bull market as China and other rapidly growing economies continue to boost domestic consumption and increase trade.
The credit crisis is a Western problem, not an Asian one. Balance sheets across Asia are not restricted by sub-prime losses or other mortgage-related write-downs. So the sooner the U.S. finally tackles the credit crisis, the sooner Asian growth will reaccelerate. That's when I expect commodities to bottom.
The long-term picture remains bullish for these markets and commodities. Over the next 12 months, I see the greatest reflation trade of the century hitting the markets, courtesy of the United States government and the European Union.
ERIC ROSEMAN, Investment Director
EDITOR'S NOTE: Commodities may be down this year, but there's been a persistent bull market for the last seven years running. And commodity bull markets generally last 15-20 years, so this is a great opportunity to get in while the prices are low. To learn how to take advantage of this buying opportunity, take a look at America's #1 Research Service, Commodity Trend Alert (CTA). Click here to find out more...
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