Deflation Fears Pound Commodities

09/17/2008 12:00 am EST

Focus: COMMODITIES

Eric Roseman

Editor, The Commodity Trend Alert

Eric Roseman, editor of Commodity Trend Alert, says the deflation scenario rules the markets—for now.

What we’re seeing now is a market that has gone from being obsessed with inflation just two months ago to one now worried about rapid deflation or an environment of declining prices. Combined with bad economic news overseas, the US dollar has seen a violent reversal since August 8th vis-à-vis all currencies, exacerbating the plunge in raw materials. It’s been a brutal sell-off and the worst decline I’ve seen since mid-2006.

So now we’ve got fears of deflation threatening the financial system and increasingly, the global economy (as recessions emerge in Europe, Japan, the United States, and other parts of the world) under the weight of soaring energy prices, rising food costs, and a starved credit system that’s stifling global cross-border lending and financing.

The most widely followed commodity benchmark is the S&P Goldman Sachs Commodity Index (S&P GSCI). The Reuters CRB Index is also popular, but unlike the GSCI holds a relatively smaller allocation to energy futures.

The GSCI peaked in early July and has now plummeted [more than 25%]. Most of that decline is courtesy of crude oil and other energy futures, which represent a hefty 76% weighting. The CRB Index, more broadly diversified and holding 39% in energy futures, has tanked [more than] 22% since July 3rd.

As it stands right now, these indices are extremely oversold. The absolute worst thing we can do is sell now and run for cover. Prices have already crashed, and we’re sticking our core themes in gold, energy, and selective reverse index hedges. Prices for gold stocks and energy stocks, including the drillers, are bombed-out and should be aggressively accumulated now! At these prices you will probably double your money over the next 36 months.

As a commodity investor you should focus on four main ideas for wealth accumulation from now until 2011. Each of these sectors are massively oversold and represent incredible upside as the investment crowd returns from their deflation obsession over the next few weeks or months:

1. Gold stocks and gold bullion

2. Energy stocks

3. Offshore oil drillers

4. Uranium

Eventually, we’ll start buying the smashed-out agricultural commodities, too. But first, concentrate on these four core investment ideas and remember to apportion a 20% allocation to reverse indexing in oil stocks, base metals and a long position in the US dollar.

As the credit crisis eventually finds a bottom—probably some time next year—commodities will have already long recovered. The market is now fighting deflation and needs the Federal Reserve’s help to quash declining price trends across the beleaguered economy. I expect the government will eventually be successful through the spectacular expansion of credit over the next 12 months. This will pave the way for another bull market rally for commodities as inflation catches up with deflation again and consumer prices accelerate. For the Federal Reserve and other central banks it still remains an environment of “inflate or die.” Bet on inflation.

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