commodities rally to continue

  1. 9,081 Posts.
    A number of analysts are pointing to the prospect of a new, long term uptrend in commodities.

    Huntley for one says the time may be close to climb aboard for the next long term commodities bull markey cycle. He favours the well established heavyweights as the first stocks to "run" with second-liners and the lesser light to follow once it is clear that the trend is established.

    It's early days but it is something to keep in mind.

    Remember the adage about the "early bird"?

    Here is another report from an analayst who has a similar view:

    By Andrew Kashdan

    The U.S. economy, formerly the growth engine of the world,
    has been sputtering recently. That's causing most
    economists to push back their targets for the strong, self-
    sustaining recovery that was supposed to have started
    already...according to the earlier forecasts of these same
    economists. Europe and Japan are hardly in a position to
    take up the slack. So the question for us is, "Can
    commodity prices continue to rise in this environment?" To
    offer a preview: Yes.

    Over the long term, it is clear that during periods of
    strong economic growth, commodity prices tend to rise, and
    during periods of weakness, prices tend to fall. But the
    CRB Index of commodity prices tracks nominal GDP more
    closely than it does real GDP. This fact is not too
    surprising, given that the CRB simply measures the nominal
    price of a basket of commodities. In other words, inflation
    may be more pertinent to the recent commodity price trend
    than GDP growth, per se.

    Over the past year or so, for example, the rallying CRB
    Index has had little to do with GDP growth. In the last few
    quarters, the Economic Cycle Research Institute (ECRI)
    leading indicator of economic growth has shown clear
    periods of improving or deteriorating economic growth. Yet,
    commodity prices have maintained their upward trajectory
    regardless of the economy's up-and-down growth prospects.
    The CRB Index has advanced steadily to post a nearly 30%
    gain since the beginning of the year. Meanwhile, actual and
    expected rates of inflation have been heading higher, even
    as the economy remains weak, and that's what is showing up
    in the CRB. Inflation seems to be the message from the
    commodity pits.

    The Treasury's inflation-indexed bonds tell a similar tale.
    The inflation rate "anticipated" by the 10-year inflation-
    indexed bond has increased by about 30 basis points to
    nearly 2%, in just the last few months. And you wouldn't
    know it by reading the papers, or listening to our chief
    inflation-fighter at the Fed, but actual inflation has been
    rising, too. On a year-over-year basis, the CPI has gone
    from 1.1% last June to the latest reading of 2.6%. Not
    quite a repeat of the stagflationary 1970s yet, but not
    deflation either. The recently released ISM prices-paid
    index jumped to 65.5 from 57.5, surpassing its long-term
    average of 62. And after two months of declines in the
    Producer Price Index, the January PPI jumped 1.6%, boosted
    by a 4.8% rise in energy prices.

    One central bank, at least, has already glimpsed the near
    future. The Bank of Canada raised rates another quarter-
    point this week, taking the overnight rate to 3.25%, up
    from 2% since the start of 2002. Canada's inflation rate is
    running at 4.5%, a 12-month high, due largely to high oil
    and natural-gas prices.

    Net-net, the current commodity rally seems to be about
    resurgent inflation, rather than resurgent economic
    activity. And if Fed Governor Ben S. Bernanke has his way -
    remember, he's the one who promises to crank up the
    "printing press" to fight deflation - this commodity rally
    has a ways to go. What is more, one aspect of the current
    commodity rally is not widely appreciated: it is not just
    oil that is powering the rally. Nearly all commodities are
    in "rally mode" to some extent.

    Curiously, the stock market is full of skeptics about the
    ongoing commodities rally. Very few resource stocks have
    kept pace with their related commodities. And that bizarre
    divergence may present a terrific investment opportunity,
    even for the most cautious of commodity bulls. If we are to
    "trust" the CRB rally, numerous resource stocks are a
    strong buy (and, by the way, long-term bonds are a
    screaming sell). Over the last several months, the XOI, XNG
    and XAU - indexes for oil, natural gas, and gold and
    silver, respectively - have barely budged, despite
    substantial rallies in their related commodities.

    For example, let's take a look at the XNG Index of natural
    gas stocks relative to the price of natural gas itself.
    Natural gas prices have soared more than 260% over the past
    year and a half. Amazingly, however, the XNG Index - which
    consists of 15 major gas producers - has actually declined
    by more than 8% over the same period! A similar divergent
    pattern is seen in the oil markets. The benchmark WTI crude
    oil price has nearly doubled since late 2001. Even so, the
    XOI Index of oil stocks has dropped about 13%.

    Likewise, the XAU Index of gold stocks peaked in May 2002,
    and has dropped more than 14% since then, while gold itself
    has increased by 7%. "That is a real historic anomaly,"
    says fund manager Paul Stuka, quoted in Barron's, "because
    [gold] stocks should appreciate about two to three times
    the rate of metal itself. There is something really odd
    going on." Unfortunately, for some gold investors, the XAU
    has suddenly found some leverage on the way down - the gold
    price has dropped about 5% in the past month or so, while
    the XAU has lost 12% (and the unhedged Amex Gold BUGS Index
    has dropped 13%).

    Clearly, all three of these equity indexes for natural gas,
    oil and gold are pricing in a significant downward reversal
    in the prices of their related commodities. In other words,
    the indexes, especially the XNG, seem to be discounting a
    worst-case scenario. That's funny; because we think we are
    looking at a best-case scenario for natural gas and most
    other commodities. A temporary pullback in natural gas
    prices would hardly be surprising, given the spectacular
    recent rallies. But we think that the natural gas bull
    market is the "real deal". Therefore, we suspect that the
    shares of many natural gas companies are too cheap because
    they are pricing in a worst-case scenario that is highly
    unlikely to occur.

    The weak performance of natural gas stocks, and resource
    stocks in general, relative to their related commodities
    looks like a golden opportunity. Investors may be getting a
    great chance to climb aboard a powerful long-term bull
    market in commodities, and to do so at deeply discounted

    Given the low valuations of many resource stocks, coupled
    with an inflationary threat that most investors have failed
    to notice, and a favorable long-term supply and demand
    outlook for raw materials, the resource stock party may be
    just getting started.

    - from the Daily Reckoning
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