Is the Commodities Bull Over?

09/18/2008 12:00 am EST


Howard Gold

Founder & President, GoldenEgg Investing

Once-sizzling commodities have turned ice cold.

Since topping $1,000 an ounce, gold has lost as much as 27% of its value. Crude oil, which peaked at around $147 a barrel, changed hands at about $91 Tuesday, a sickening 38% decline. (Both rallied sharply in Wednesday’s flight-to-safety panic.) Agricultural commodities have taken it on the chin as well.

Investors who piled into hot energy and precious-metals ETFs over the past year have been whacked as fears about financial collapse overwhelmed worries about inflation.

So, is the party over? Are we now in a bear market in commodities?

“Absolutely not,” declares Curtis Hesler, editor of Professional Timing Service, a newsletter that focuses on commodities.

“Commodities are volatile,” he argues. “A correction of 30% to 40 [is normal].”

“You can’t use bear markets in stocks to define commodity corrections,” agrees Eric Roseman, editor of Commodity Trend Alert.

“We’ve had a huge run in commodities. It was a very overbought asset class. It was out of control,” he says.

But the case for commodities remains intact, both say. Tight supply and strong demand, particularly in emerging markets, should help commodities and shares in mining and energy companies rebound later this year.

I have my doubts, and I’ll tell you why later.

As with most commodity bulls, the fundamental argument comes down to China. “China is still the number one user of commodities,” says Roseman. “The Chinese economy has a big backlog of domestic infrastructure [projects].” That’s stoking demand for steel, copper, aluminum, concrete, all the industrial materials needed to build a modern economy.

And China’s economic growth remains strong—close to 10% this year, and inflation has tailed off, to 7% annually, allowing the government to push a growth rather than anti-inflationary policy. And China has $1.8 trillion in foreign currency reserves to keep funding its infrastructure needs.

But its biggest customers in the developed world are either in recession or heading there fast. Growth has plummeted in Europe and Japan, and we all know what’s happening here. Meanwhile, trading partner Russia’s market and currency are imploding. With 40% of China’s gross domestic product devoted to exports, that’s all got to hurt.

Also, some of China’s Asian neighbors are pulling back on infrastructure spending as their economies weaken and markets fall. India especially had to cancel projects when funding dried up because of the credit crunch.

Can China remain the Atlas that holds up the world of commodities? Its markets certainly don’t give us reason for confidence: the Shanghai Composite index has lost two-thirds of its value since its peak last October and trades below 2,000. Hong Kong’s Hang Seng index is off 44%.

True, both those exchanges are quirky—Shanghai is like a casino, while Hong Kong is heavily tied to real estate development. But they’re also where many Chinese companies raise capital for expansion, and where many Chinese invest their savings, so they must be telling us something.

In fact, demand for automobiles in China dropped 7% in August from the same month a year ago—the first decline since the Asian financial crisis of 1998. Clearly, Chinese consumers are feeling the pinch from the global financial squeeze and the collapse of their own stock markets.

The rebound in the US dollar hasn’t helped commodities, either. For months, speculators sold the greenback, driving it down to 1.60 euro.

But since July the dollar has been on a tear, hitting 1.40 euro before this week’s pullback, when investors abandoned the greenback in a flight to “safer” assets like gold and short-term Treasurys.

If the US dollar index—a measure of the dollar against several currencies—stays above the key resistance point of 80 it hit earlier this month (it traded at around 78 Thursday), then it could move much higher in coming months. That would be very, very bad for commodities.

Also, during their big run, commodities like oil and gold rose along with inflation fears. It became a vicious circle as rising energy and food prices stoked inflationary expectations and traders and speculators responded to that by buying more commodities.

But as concerns about deflation grew, the case for commodities became less compelling. Declining output and shrinking asset prices are not the most hospitable environment for rising commodities prices.

“If the credit crisis doesn’t go away soon, then all bets are off,” concedes Roseman.

But he thinks the crisis might have the opposite effect as central banks pump money into the system to keep it afloat. On Thursday, they added $300 billion in fresh liquidity.

“The only way for the government to get out of this is to expand credit,” he says. Sooner or later, he adds, that creates inflation, which is good for commodities, especially precious metals.

In fact, Roseman now likes the shares of gold mining stocks, which he says are at their lowest price relative to gold itself since 1985. Hesler also recommends the miners, as well as oil drilling and services stocks.

That sounds reasonable enough, but consider this: corrections in commodities can seem like real bear markets to people who live through them.

During its last multiyear bull market, gold peaked at around $185 an ounce in February 1975.  It then went down, down, down, before bottoming out around $103 in September 1976. That’s a 44% decline over 19 painful, miserable months.

Gold then went on a tear, eventually hitting $850 (for one day) in January 1980. But I wonder how many burned investors actually stuck around to enjoy the ride.

By the way, a similar decline now would take gold to under $600 by the fall of 2009. Doesn’t sound like a “flight to safety” to me.

Hesler is convinced that won’t happen. Like many commodity bulls he believes we’re in a long supercycle that will take all these commodities to much higher levels over the coming years.

“I think for all intents and purposes, the worst is behind us,” he says.

I hope he’s right, for any number of reasons. But I wouldn’t bet the bank on it.

Howard R. Gold is executive editor of The opinions expressed here are his own and are not necessarily the views of InterShow or
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