Today's comment is by Eric Roseman, Investment Director of The Sovereign Society and Editor of Commodity Trend Alert.
Dear A-Letter Reader:
For the third time since March 2005, commodities are in the midst of another brutal correction. And like previous declines in this secular bull market since 2002, investors should accumulate shares of great resource companies at bargain prices. But commodities aren't the only sector getting slammed in May; the majority of global equity markets are now hitting two-month lows as a long overdue correction finally slams high-flying bourses from Brazil to India. Indeed, since the bear market low in October 2002, major and emerging market stocks have not suffered more than a 7% correction off their highs.
The trigger for the global sell-off is fears of higher U.S. and international interest rates to combat rising inflation. In the United States and Germany, April consumer price data hit their highest levels in years while in many emerging markets, inflationary pressures are increasing. Wage growth, a key variable determining Federal Reserve monetary policy, has remained historically low until the first quarter. For the first time this decade, wage growth is now outpacing the consumer price index, a signal to inflation-hawks that cost pressures are rising in the United States. Gold prices, which have surged from $420 an ounce just 12 months ago to over $650 an ounce currently, strongly suggest that inflation is a growing concern for global investors.
Prior to May 15, global investors had started to discount either a pause in U.S. Federal Reserve monetary tightening, or possibly, one last rate hike on June 29. Increasingly, however, it appears that the Fed will raise short-term rates higher than market expectations to quash the inflation threat. Rising interest rates are commodities' worst nightmare; the market is now digesting a prolonged tightening cycle in the United States, which explains why natural resources are coming undone this month.
Commodities have been on a tear since last fall. All major commodity benchmarks now trade just under their all-time highs, including the CRB Index, the Goldman Sachs Commodity Index and the Dow Jones-AIG Commodity Index. Since stocks peaked over six years ago, no other asset class has come close to outpacing the huge returns generated from the red-hot energy, base metals and precious metals sectors. But like all bull markets, corrections are a natural progression of the primary trend. Investors, instead of running for the hills, should embrace the ongoing correction with selective purchases in the gold and silver-mining sectors, agricultural commodities and the energy complex.
As for the Federal Reserve and interest rates, the United States cannot afford to aggressively raise the cost of borrowing. Real estate, the backbone of the economy in the post-2000 period and a major source of consumer discretionary spending, is clearly slowing since last fall. All major categories of the real estate market are unraveling, including refinancing, new housing starts, existing home sales and speculative purchases in many of the "bubble" markets across the country.
For commodities investors, the spectrum of lower interest rates six-to-twelve months from now combined with a sharply lower U.S. dollar will catapult raw materials to newer highs.
A slowing real estate market just might be a commodity investor's best friend in 2006.
ERIC ROSEMAN, Investment Director
on behalf of The Sovereign Society