A look forward to commodities in 2008.
Themes for 2008, part one
Themes for 2008, part two
Themes for 2008, part three
Commodities have been a booming area to be invested in for many years now. Whether that growth continues depends on multiple variables for each different class of commodities. During a credit boom, all assets generally rise in price. But during a credit bust, the same is not always true. Some commodities will diverge from others.
Precious Metals
I continue to believe that the gold market is one of the better investments out there, either in bullion or in mining shares. The longer this credit crisis persists, the more inevitable it is for holders of declining asset prices to mark down the value of investments on their balance sheets. This destruction of credit is very deflationary. As it becomes more apparent that banks do not have nearly as much money as has been deposited, and whose assets are not liquid at prices they consider to be ”normal,” the potential for bank runs by depositors becomes more likely. The uncertainty of solvency of governments and banks around the world will be a key driver for the price of gold in 2008. Gold’s inherent value is as an alternative currency in the face of threats to the legitimacy of fiat money. Times of monetary hyperinflation or credit deflation are both very good times to be invested in gold. Times of monetary disinflation or credit inflation are the worst. Understanding the difference between money and credit is imperative to this discussion. The technical picture on gold is very bullish, and it cannot be ignored that the possibility of a large run-up is in the process of happening on not only gold denominated in US dollars, but in all currencies. A 75% increase like the one we got in late ‘05-early ‘06 gives us a price target of $1137 by the spring of 2008.
Click here for full sized chart
Click here for full sized chart
Further bullishness in the precious metals complex is being shown by platinum, which has already broken out from its November highs and is making new all-time highs on a daily basis as we close out 2007. Is platinum leading the way?
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I also believe silver is in a good spot to benefit from another leg up in the precious metals. The gold to silver ratio is at a historically high ratio (55.6), and if people begin to buy physical bullion as I think they will, this ratio will decline. The reason is simple. Buying an ounce of gold is extremely expensive relative to buying a few ounces of silver. If I were an ordinary Joe (okay, I am an ordinary Joe) and I wanted to buy some bullion with a portion of my paycheck, what would I buy? That logic prevailed during the last parabolic run in gold (1980), when the ratio closed to about 17 at its peak.
Industrial Commodities
I am wary of what the perception of an economic slowdown will have on the industrial commodities. I understand that real demand will be minimally affected by a potential worldwide slowdown, and there is relatively little new sources of supply coming on to the market like there was preceding other commodity bear markets. But perception is stronger than reality, so the possibility of large price declines remains a possibility in energy and industrial metals. It is not something that would lead me to short the market, but is enough to prevent me from taking large long positions.
With that in mind, we must respect that the traders of these commodities are, in general, far more sophisticated than your average equities trader. Therefore, the possibility remains that any future pause in Chinese or other emerging market growth has been priced in already. If those growth slowdowns don’t materialize, there is the potential for a blow off rally in these commodities as holders of U.S. debt go on a spending spree, buying up raw commodity supplies.
The technical positions of commodities like copper are interesting. Looking at a chart, I don’t see any reason for pessimism in the copper market. If I had to bet on prices being higher or lower in the next year, I would bet higher. The trend of falling prices into year-end is looking very familiar to last years’.
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Similarly, the global growth story will have great impact on the price of crude oil. Whether that is already priced in or not is hard to say. But demand is only one half of the equation that leads to the price. Finding oil is becoming increasingly difficult, and alternative sources are not growing fast enough to impact the overall energy picture. I am a believer in peak oil. Although there are numerous prospects for utilizing other sources of oil (U.S. tar sands, arctic oil, etc.), the costs involved in recovering it are prohibitive. The argument is that as prices rise, these sources will become more economic. That ignores the fact that the costs in recovering the stuff (which are largely energy related themselves) also rise. Eventually, it costs just as much in energy inputs as the value of what is yielded. Therefore, I believe oil prices, over the long term, will continue to rise. In the short term oil could pullback on concerns of recession in the U.S., but I don’t think the drop would be too far. I foresee oil trading in a range between $80-120 in 2008. Technically, there’s not much to see. The price is moving from the lower left to the upper right. It will take a lot to change that.
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Agriculture
Speaking of moving from the lower left to the upper right, take a look at agricultural commodities. Agriculture is also affected by high energy prices. Producing corn, soybeans, cotton, etc. is very energy intensive. It doesn’t help that a large portion of the food supply is being taken to produce energy either. As more corn is being used to produce ethanol (another exercise in futility that costs as much in energy inputs as is yielded) farmers switch over their crops, driving up prices in just about everything we eat. I like agriculture in 2008 as much as I did for 2007 and for the same reasons. There is potential for massive price increases in this arena if agriculture is to catch up to other commodity prices.
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Still to come are technical views on the currency and equity markets and how they will be affected by adversity in the credit markets in 2008.
This article was written by a member of the Stockhouse community.
