Window to buy low on these commodities is closing

Prices have fallen to a level that has altered the supply/demand dynamics in these sectors, which has created a limited-time opportunity to profit.

By StreetAuthority Aug 27, 2013 3:22PM
Image: Coffee © Foodcollection RF, Getty Images, Getty ImagesBy David Sterman

When the Federal Reserve launched its plans to stimulate the economy through quantitative easing in 2009, virtually all asset classes were expected to benefit as the massive increase in liquidity would trickle through the markets. Indeed, commodity prices initially surged in tandem with stock and bond prices.

Yet commodities simply couldn't keep up, and eventually faltered. Over the past two years, the S&P 500 index has risen 40%, while the iPath DJ-UBS Commodity Index Total Return ETN (DJP) has fallen 20%. (The fact that crude oil accounts for roughly 20% of this exchange-traded fund (ETF) means that results would have been even worse if crude oil were excluded.)



Yet a case can be made that the storm clouds over commodities are starting to part. And as always, it comes down to supply and demand.

On the demand side of the equation, the discussion has focused on China, which had been showing signs of a rapid economic slowdown in the first half of 2013. Yet in recent weeks, various data suggest China's slowdown may not be as bad as feared. In a Bloomberg article this week, a fund manager at Shanghai-based Dragon Life noted that "Signs are emerging that China's economy will rebound." In fact, several economists have recently boosted their growth forecasts for the Chinese economy after a series of earlier downgrades.

But perhaps it's time to think about commodities in a global light. The Chinese market is surely important, but both the U.S. and Europe each account for one-fourth of global economic activity, and signs are pointing to growth (albeit off of a low base) in those areas well, which should lift demand for commodities.

Investors also need to track the supply side of the equation. A wide range of mining companies, from BHP Billiton (BHP) to Vale (VALE) to Rio Tinto (RIO) have all removed billions of dollars of new mining projects from their development slate. There is always a lag time between changes in capital spending and the impact on industry output, but the stage is set for a more constrained supply picture in 2014 and especially 2015.

Meanwhile, various commodity prices are showing signs of a rebound, or are at least forming a bottom. Take copper, for example, which had been in freefall, until recent economic clues out of China boosted sentiment.
If copper has indeed found a floor, then Freeport-McMoRan (FCX) is well positioned for upside, as I discussed recently on StreetAuthority.

In a similar fashion, agricultural commodity prices are showing recent signs of stabilization after sharp drops. Corn prices, for example, appear to have fallen to a level that has led poultry and cattle farmers to step up their purchases.
And the spot price for soybeans appears to have also made a bottom.
Perhaps the best way to capitalize on the apparent bottom in agriculture prices is the PowerShares DB Agriculture ETF (DBA), which made a 52-week low in early August before a recent modest rebound.

Investors should also explore the opportunities emerging in coffee after prices plunged to multi-year lows in the face of a robust global harvest. These sharp swings in coffee always tend to set the stage for their own reversal as low prices lead some major coffee traders to withhold supply from the market. The iPath DJ-UBS Coffee Total Return Sub-Index ETN (JO), has plunged from nearly $43 to $23 in the past year, and is well below the $80 level seen back in early 2011.

Selectivity is key
Not all commodities are poised for a rebound anytime soon. Finished commodities such as steel and aluminum are still dogged by too much industry capacity.

And trying to get a handle on the direction of gold prices is quite hard, simply because demand from places like India and China is proving to be fickle. According to the World Gold Council, roughly half of all gold bars and coins are being bought in those two countries. Yet the Indian government has raised taxes on gold imports on three occasions since the start of 2012 to blunt a staggering trade deficit, which could eventually crimp Indian demand.

What about natural gas? The spot price has plunged from $4.30 per thousand cubic feet (Mcf) in May to a recent $3.55 per Mcf. Benign weather patterns, which crimped summertime electricity demand, are the key culprit. And gas isn't especially timely as we enter the shoulder season between summer and winter. Yet it pays to continue to track this commodity, which is far closer to a supply/demand equilibrium than it was a few years ago when gas prices plunged below $2 per MCF.

Risks to consider: The biggest risk for commodity prices is on the demand side. If the Chinese economy falters badly, then commodities will likely see new lows. For that matter, the U.S. and Europe need to show at least modest signs of growth to help boost the demand side of the equation.

Action to take:
Few are talking about commodities right now, after the sector has inflicted such deep pain. Yet it is such times that opportunities emerge. The forces of supply and demand may prove to be slow-changing, which means that patience will be required, but the stage is increasingly set for an upcycle as we head into the middle of the decade.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of FCX, RIO in one or more of its “real money” portfolios.

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