Time to Buy Commodities Again?

12/18/2008 1:00 pm EST

Focus: ETFS

Eric Roseman

Editor, The Commodity Trend Alert

Eric Roseman, editor of Commodity Trend Alert, says commodities have been bombed out, but they might rally along with world markets.

By now it's painfully clear that commodities are in a freefall. 2008 has been the worst year for commodities since the benchmarks last declined in 2001. The average diversified natural resources equity fund has tanked 56% this year, erasing all of their gains since 2005.

To be sure, investor speculation was extreme in commodities heading into July. Oil, the base metals, and some soft commodities had gone ballistic months prior to July, while others, including gold, silver, and livestock, had lagged broader commodities indices.

Still, the magnitude of this decline has been nothing short of spectacular. And I therefore ask myself whether this is not the time to start aggressively buying commodities again?

It's fair to assume that any sizable rally for commodities will be tied to gains in stocks. Both asset classes are tied to the growth cycle; any hint that economic growth might not be as dire as projected in 2009 will propel both stocks and commodities higher. Conversely, it will also smash Treasury bonds.

Commodities in the past have posted big declines within the context of a secular bull market. This is exactly what transpired in the mid-1970s when gold and other commodities got crushed; meanwhile, they more than quadrupled off their lows in 1976 and by 1980 had rewarded investors with spectacular gains.

If world markets can post a string of rallies then I fully expect commodities to participate. Commodities require liquidity. There's obviously been a dearth of cash around to trade raw materials since September, coupled with the near-demise of AIG, a major counter-party in commodities trading. We're now spectacularly bombed-out at these prices and it's time to gradually get back in on the long side.

Demand destruction has already occurred, and the market has now overshot to the downside; unless we're facing a depression—and I heavily doubt this will happen amid gargantuan government printing to break deflation—then oil is a buy.

[But] oil must hold above $40 a barrel. This is a key support level for crude at this point. If we break [below] $40, then I think it's likely we'll head to $25 a barrel, and quickly.

The iShares S&P/GSCI Commodity-Indexed Trust (NYSEArca: GSG) is an exchange traded fund that is now 64% off its all-time high in July. That's a serious crash. The index is heavily tilted towards energy futures like crude oil, gasoline, and natural gas. With colder temperatures in the Northeast and winter about to arrive, this is the time to speculate on energy futures. Prices at these low levels are simply a contrarian's dream.

Effective immediately, buy the iShares S&P/GSCI Index Fund or GSG at market up to $30. (It closed below $29 Wednesday, while crude changed hands around $40—Editor.) Place a 20% stop loss on your entry price.

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