Stock markets staged a strong rally yesterday, January 4, boosted by strength in commodities and commodity stocks.
The Standard & Poor’s 500 stock index climbed 1.6% and the Dow Jones Industrial Average was up 1.5%. Oil (West Texas Intermediate) climbed $2.15 a barrel to $81.51. Copper hit a 16-month high at $7,536 a metric ton. Lead soared by 2.9% and tin by 3.4%.
Is this—rising commodity prices powering a climbing stock market—a trend that you want to bet on in 2010? Or was yesterday’s rally in commodity prices a one-day wonder?
Somewhere in between, I’d say.
The short-term forces pushing up commodity prices will last for more than a day. A run of months is possible.
But forecasts of another year-long run (or longer) from today’s already elevated price levels seems like wishful thinking.
My skepticism runs against the grain—or at least some of the grain–of a report from the International Monetary Fund (IMF). Commodity prices, the IMF said in a report (see it here http://www.imf.org/external/pubs/ft/survey/so/2009/RES123009A.htm ) released on December 30, 2009, will remain high by historical standards in the long term as emerging economies industrialize and in the short-term as the global economy expands at a faster pace in 2010.
I agree with the IMF’s conclusions for the long-term: I think growth in China, India, Brazil, Viet Nam, and other developing economies will keep demand close enough to supply to keep commodity prices climbing over the next decade.
It’s the short-term conclusion that I’ve got to differ with.
2009 saw the biggest annual increases in commodity prices in four decades as prices rebounded from the lows of early 2009. The IMF’s commodity index climbed 40% in 2009 from the February 2009 low. But much of that rebound didn’t reflect current demand, which remains tepid for many commodities—oil for example. Instead those price increases anticipated a rebound in demand in late 2009 and 2010. And a lot of the buying that fed into those price increases was a result of inventory restocking by companies themselves anticipating a need for increased supplies of raw materials to meet higher orders from their customers.
Looking at current inventory levels at commodity consumers and current excess capacity at commodity producers, I can’t find the kind of constrained supply situation that would push up commodity prices at a hefty pace in the near term, say the rest of 2010.
The IMF report actually concedes this point, noting that commodity price gains in 2010 would be “moderate” due to above average inventories and substantial space output capacity.
A skeptic such as myself looking at Monday’s rally in commodities sees lots of very temporary forces at work to push up commodity prices. There was a cold wave in the United States that sent up oil prices on speculation about an increase in demand for heating oil. That same cold wave set off fears of further delays to the last stages of the corn harvest and of damage to the Florida orange crop that led to increased prices for corn and orange juice futures. A strike at Codelco, the world’s largest copper producer, produced higher copper prices. These all strike me as short-term events and not the basis for a big 2010 rally in commodity prices.
You can argue that these short-term events are merely evidence of longer-term imbalances of supply and demand. The Codelco strike wouldn’t be able to move copper prices so strongly if copper capacity wasn’t so tight, the bulls currently argue.
But to my way of thinking, to see a big commodity rally in 2010, you’ve got to believe in a scenario where economic growth in the United States is strong enough to increase global commodity demand but not strong enough to produce a Federal Reserve rate increase in 2010 since that would lead to a stronger dollar. Which would push down commodity prices.
To me that sounds like asking the financial markets to thread a pretty small needle. Not to say it can’t happen but the odds of it not happening are pretty good.
So it shouldn’t surprise you that the commodity markets are the scene of a hard-fought war right now. The consensus of analysts surveyed by Bloomberg calls for as much as a 17% increase in the prices of oil, corn, gold, and palladium in 2010. Goldman Sachs estimates that the S&P GSCI Enhanced Total Return Index of 24 commodities will gain 18% in 2010. Energy with a 25% gain and metals with a 15% gain will lead the index.
Investors put $60 billion into commodities through exchange traded funds (ETF) in 2009 according to Barclays Capital. A December survey of 250 investors by Barclays projects that investors will put at least that much into commodity ETFs in 2010.
Which has led some prominent money managers to take the other side of the trade. For example, Barton Biggs, the manager of Traxis Partners, is buying household-product stocks such as Procter & Gamble (PG) and shorting commodities.
Any big contrarian bet is a play on a stronger U.S. dollar. If the dollar continues its end of 2009 rally, 2010 will turn into a tough year for commodities.
With this much uncertainty and this much risk, I wouldn’t put big bets on a basket of commodities on either side. In 2010 I’d avoid commodities such as oil with abundant supply sitting on the sidelines and questionable demand growth. I’d take a pass at the highest flyers of 2009—lead was the best performing industrial metal in 2009 (up 143%) but is forecast to show a modest decline in price in 2010—and look for areas of tight supply that are likely to lead to sustainable price gains in 2010. Three areas to target, in my opinion, are iron ore (with annual price negotiations pointing to higher prices in 2010), fertilizer (with rising corn prices giving farmers more cash to put to work in their fields), and molybdenum (on rising auto global auto production.)
FSUMF
However, if GS is correct and contracts settle near 111 a ton, that’s a nearly 100% increase for FSUMF. I think they were getting 57$ ?
AND I have heard other people saying the contract price could settle higher… And with spot prices at 124$, that’s also a good thing, but I don’t know if FSUMF has space capacity to sell on the spot market…or if everything they dig is contracted for. I believe I read an article a month or so ago that stated they were no longer selling to the Chinese at the 33% discount that they had settled on, so maybe investors are buying with the idea that they could nearly double profit next year… Hard to say…
Very unusual movement for fsumf, I fully expect it to drop back to 4.50….
Iron Ore Reaches High as Goldman Sees ‘Panic Buying’ (Update2)
But this really dosnt explain whats going on over at Fortesque….. A nearly 400% increase in volume usually indicates thats somethings up…
http://www.bloomberg.com/apps/news?pid=20601087&sid=aQC6LbPuMLmk&pos=7
Today was crazy… FSUMF up 13%, but POT, TC, RIG and GLF also having very good days. Market is mostly unchanged. Where’s all the buying coming from?
Well thats good news for Iron ore…
From
http://www.bloomberg.com/apps/news?pid=conewsstory&tkr=FSUMF%3AUS&sid=a4AUNTnxkofQ
“With spot iron ore now trading at a theoretical premium of 80 percent to the Japanese contract price there must be a growing motivation for mills to lock in contract prices sooner rather than later,” Goldman analysts led by Malcolm Southwood said in a report dated yesterday. Mills may “concede bigger price hikes than our plus 20 percent forecast” for Australian ore, he said. ”
Spot on Jim (No pun intended)
JJ- have to agree with your short-term assessment. The fly in the IMG’s l.t. outlook on imbalances is EM growth. If the US consumer doesn’t come roaring back the commodities demanding countries (China) will reduce their demands from the exporters (Brazil). That said because so much of the reserves are behind political barriers and the developed resources in front are aging (cf. Mexico, Russia) imbalances will persist but could be less. Sadly that’ll mean a commodity by commodity assessment rather than a blanket one.
I am with EdMcGon. When it comes to commodities, check out how the emerging countries are doing, not the US. A little gain in the price of oil translate into better living standards and this in turn brings about a higher demand for metals and food. Check out especially Russia.
I like the thinking here, only because it parallels mine (could there be a more short sighted reason to like something?)
My concern with Iron ore is, everybody and their brother is rushing to add capacity to mine ore. BHP, RIO, Vale and FsumF are all expanding capacity at a break neck pace.
At some point soon there is going to be more ore available then the market needs. But when is that going to be?
We read more and more about countries like Brazil, Russia, India and China that have to upgrade, or build out, infrastructure to stay competitive,
not to mention the fact that China alone has to build 6 new cities a year to service people wanting (Or needing) to move into a city setting (I think Jim wrote that some time back)
We still have quite a bit of “stimulus” dollars directed to these projects in the pipeline.
Both Spot and contract prices for Iron ore seems likely to rise 15-20% in 2010 (Depending on who you listen too)
But, I can’t seem to come up with an intelligent time frame for when these two opposing forces become unbalanced.
Anybody have a comment?
Jim, this is speculation on my part, but I don’t expect the Fed to tighten enough to give the dollar more than a slight nudge towards strength. With unemployment still high, Bernanke will only dip his toe in the tightening waters, if he does anything. The Fed won’t make any serious efforts this year. Do I even need to mention the Fed does not historically move rates during elections? This means there should be a period around the end of the 3rd and start of the 4th quarters when the Fed does nothing.
All that said, I expect commodities to be the inflationary canaries in the coal mine. If they go up a little as you project, it’s probably no big deal. However, if they have another year like last year, we will have major problems.
Jim:
Your commodity picks were great in 2009. I’ve done quite nicely with FSUMF and POT and plan to hold on to them for some time (though every time POT has a 10%+ run in the space of a few days, I am tempted to sell and try to get back in later). I deeply regret not being more greedy with TC (but am scared to re-enter at this point).
But what to do about Petroleum laggards like RIG and GLF? Will you unload these based on your reasoning above or try to hold on for a better exit point?
Appreciate your thoughts!
JJ,
I am in agreement here. My portfolio has been heavily geared towards energy and commodities. They have made me happy during the last year, however it seems oil and energy, more than most sectors, may have a really weak trend in 2010. It appears time to unload some of the overweight positions.
however with POT and BG up roughly 100% over the last year does anyone think now is the time to buy more in order to overweight agri-companies?
Phenomenal. I was worrying about these very things since Monday when you posted regarding the typical cyclical January sector changes that appear to be developing, which were in contrast to commodity prices. Thanks as always for impeccable timing and consistency in following up on your themes when things change. I’m heavy on commodoties and my greed is keeping me in when I make several percent a day on my portfolio. Thanks for the excellent background info to help temper my greed from your excellent picks and target the right commodities!