This Commodity Boom May Not Bust

04/07/2011 2:00 pm EST

Focus: COMMODITIES

Floyd Upperman

Author, Commitments of Traders

Changes in the markets and growing overseas demand could keep commodity prices at elevated levels indefinitely, says author and commodities expert Floyd Upperman.

Joining me in the MoneyShow.com video network studio, Floyd Upperman. Floyd, I know you follow commodities markets, where are we in the cycle?

Well we’re in a boom cycle and we’ve been in this boom cycle now for quite a while, and it may continue for a while. 

Last time we were in a major boom like this was when we really went off the gold standard. When Nixon took us off the gold standard and commodities moved up in price. You’ll notice it never moved back to the old price ranges. Now that doesn’t happen all the time. 

Commodities tend to be boom-and-bust kind of markets where we go through a boom cycle for various reasons; could be supply problems, could be an increase in demand, a short-term increase in demand, could be a war, there’s a lot of things that can cause it, but generally they’re short-lived events and the price will bust back to its old price range. 

Well this time that’s not happening. You look at crude oil today is trading close to $100 a barrel again. We had a major boom in that market where we went up to $145 a barrel. Then we came back down but we did not get back down into the previous price range.

Same thing with gold and all these other commodities. Again, that doesn’t happen all that often. The last time it happened was in the late 60’s and early 70’s.

Why do you think we’re seeing the shift now?

Well there’s a lot of reasons for it. There’s some policy changes hat have taken effect that are causing this with the swaps. The swaps, if you look at these swap dealers and these swap positions, it’s a huge…it dwarfs actually the futures market, the physical futures markets. 

In 2007, the Bank of International Settlements reported that the total value of the swaps were $156 trillion. At the same time for 2007, the total value on the physical futures market was $9 trillion, so you can see it’s a huge market and that market is becoming more intertwined and more part of futures and it’s driving also the price moves that we’ve seen, the booms that we’re seeing in the futures market. 

That’s part of this perfect storm scenario that’s driving prices higher, but in addition to that, we have all this demand from overseas, China, and India, with all the growth that they’re having over there. This is real growth that’s not going to stop, it’s likely to continue to just get bigger and bigger, that too is driving prices higher. 

Then also weather problems, which tend to be a part of the boom and bust cycle, those aren’t permanent, but these other things are permanent. 

Like with China, for example, where they have literally a billion people moving up into the middle class, millions of them moving up into the middle class. They’re not going to move back down, and they’re going to continue to demand more and more commodities. Whereas China for many years was an exporter of lots of commodities like cotton, for example, they’re now an importer. They’re not likely going to change that. That demand is not going to go away so prices are not backing off, they’re not likely too.

So how can a trader instead of looking at individuals, participate in the whole commodity boom?

Yeah, well again, I use the COT (Commitments of Traders Report) to kind of understand where we are in these boom-and-bust cycles, but there are times when we get into these periods, this shift, where we stay at a boom.

That’s also…you can use the COT to help understand that as well, but you have to use it a little differently there because you’re not expecting, you’re not going to be waiting for a big commercial positions, for example, or big fund positions to unwind to sort of start a whole new move. 

You’re looking for smaller changes in the data, corrections, dips. If you notice like commodities, when they dip nowadays, they don’t dip very much. That’s because there’s so much money out there that as soon as there is a little dip, it starts jumping in and buying those markets and then that prevents the dip from getting any bigger.  You have to look for smaller corrections when we’re in this kind of paradigm shift right now.

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