How Far Can Commodities Rally?

05/19/2009 1:00 pm EST

Focus: COMMODITIES

John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says commodities look strong, but he cautions against using gold as a hedge against anything.

Quietly, while no one was paying attention, commodities formed a double bottom and turned higher. There has been little if any coverage of this. However, demand for commodities seems to be quickening, which makes sense if you consider the massive drawdown in inventories. In normal times we would take this quickening to be a leading economic indicator, but these are extraordinary times. So we'll file it as an alert and look for confirmation.

[Meanwhile,] very quietly crude oil formed a base, broke out, and then consolidated just above the breakout point before resuming a now-confirmed rally. We are quite bullish on the entire energy complex and note that, as expected, the leadership is the oil service sector.

However, the big integrated oils are where the story has shifted. We are in the eighth month of a massive base that spans a range from 750 to 1,000 for the Amex Oil index (XOI). Importantly we are just at the upper end of the range and look perfectly poised to break out. Chevron (NYSE: CVX) looks beautifully set up.

The gold stocks are behaving very nicely, [too]. HUI, the equal-weighted [Amex] gold stock index, is just breaking out of a beautifully formed base that measures to new highs. Though this is a good opportunity from a trading perspective, in this cycle gold once again did not serve in its much-vaunted, but actually nonexistent, role as a preserver of capital in times of crisis.

In my opinion, the case for gold as a defensive asset is closed by its utter failure to protect and preserve wealth in the last three bear markets. The precious metals are still an interesting asset class that may, but not necessarily, offer some diversification. There also may be some monetary linkage, but the evidence for that is poor, as is the evidence of its role as an inflation hedge: The real value of gold has been whacked in half from its 1980 $850 peak to its recent new high.

To wit, the real value of a dollar invested in gold at the 1980 peak of $850 is approximately 44 cents today. To be fair, had you bought at the low of $102 in 1976, you’d have done better, up a real 250% for about a 4% per year real return, but that still lags stocks.

The dollar index is really in must-do territory. The up trend defined by the mid-2008 lows and the December lows has been broken, and very important chart and psychological support lies just below the current price; call it 80ish and mark it with a broad brush.

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