Rumors of the Demise of the Commodity Boom

September 10, 2008 at 7:05 pm
Contributed by: Chris

Here’s my article this week for Energy and Capital, discussing the huge selloff in commodities & energy after the Labor Day weekend.
–C

Rumors of the Demise of the Commodity Boom

Playing to Win with Captain Contrarian

2008-09-03

By Chris Nelder

The first day back to work and back to school after the Labor Day weekend was a wicked one for commodity and energy investors.

Gold slid 3%, or $25, to $810.50 and ounce, a level it has not seen since its most recent low on August 18 at the end of the last huge commodity/gold/energy selloff.

Crude oil fell intraday to $105.46, a five-month low, and closed at $109.71, the first violation of the $110 floor since the huge run began at the beginning of the year.

Gasoline futures fell 9% to $2.73 a gallon.

One of my favorite agricultural commodity ETFs, the PowerShares DB Agricultural Fund (AMEX: DBA) gapped down 4.7% at the open, recovering over the day to close down 2%.

The dollar rose to a seven-month high against the euro, and an 11-month high against a basket of six major currencies.

Energy stocks were universally thrashed, some suffering double-digit losses at the open…including lots of great stocks in great businesses with ridiculously low P/Es.

Even corn and soybean futures fell about 5%.

On the whole, I took a 5% haircut on the day, and I know I wasn’t alone.

It was enough to make me wonder for a moment if my whole thesis—about going long gold, commodities, and energy and shorting the dollar, the major markets and the financials—could somehow be wrong.

All in all, August and the first trading day of September have beaten the commodity and gold complex like a rented mule.

Conventional wisdom on the Street was nearly universal: Commodities and gold have simply fallen out of fashion, the dollar’s going higher and oil is going lower.

A Bloomberg story explained: "’The sharp drop in crude prices is the driving factor behind the weakness in grains markets today,’ Toby Hassall, an analyst at Commodity Warrants Australia in Sydney, said by e-mail. ‘The fear premium that had been built into crude prices was hastily wiped away.’"

Yeah, yeah, that’s the ticket! Lower crude prices should instantly translate into cheap grains!

Spare me.

Captain Contrarian Weighs In

To check my sanity, I did what I often do when I want a good read on the day’s action, and what the markets were thinking: I called up a buddy who manages money for a large financial institution. I have to protect his anonymity, so I’ll call him Captain Contrarian, because he’s generally a contrarian.

"I’m sticking to my guns," he said, then proceeded to lay out his case once again. Buy oil, short the financials, buy commodities, buy gold.

I found myself in complete agreement with the Captain. The herd turned tail and sold off the whole gold/energy/commodity complex, and overdid it, as usual.

For example, there is no sensible way to explain how a weaker-than-expected Gustav would justify whacking corn by 5% and stalwart coal producers like Arch Coal (NYSE: ACI) by 14% at the market open.

It’s not like corn is suddenly going to be in less demand, or that we’re going to see some crazy corn surplus after a year of intensely challenging weather.

Nor is China suddenly grinding to a halt, or cutting its demand for coal. Quite to the contrary, in fact, as I have argued at length in these pages.

In many ways, Tuesday was just like the action in the first part of August, and my take is exactly as it was then. (See "Is the Commodity Boom Over? Playing the Market in Upside-Down World.")

It’s just another crazy episode of the herd suddenly changing direction, selling off whole sectors. When Gustav failed to deliver a Katrina-like blow, traders sold oil, which boosted the dollar because oil and the dollar generally trade inversely, which drove investors toward unloved equities and away from the former safe haven of gold and commodities in general.

But the prevailing idea behind this turnaround is that demand destruction here in the US is so significant, that it will affect the whole world, including China. Reduced expectations for demand of energy and commodities through the rest of the year sent speculators scrambling for the exits.

And to show you that I’m an honest analyst—or at least I try to be—the action has had me re-thinking my view on the role of speculators in oil, and energy futures in general. There might be more to that aspect than I had thought.

But is my overall thesis wrong?

Not on your life.

The inflation threat has hardly been cured. And if China’s annual growth rate should drop from a lofty 11% to 9% or 10%, that will only cool the commodity trade from white-hot to bright red.

To paraphrase Mark Twain, rumors of the demise of the commodity boom have been greatly exaggerated.

When the World is Upside Down, Buy!

On a day like Tuesday, when the whole crowd is selling off everything you believe in recklessly and mercilessly, gold is down and all three of the major averages end the day in negative territory, you can really start to feel like there’s nowhere to run, and nowhere to hide.

Clearly, we’re back in Upside-Down World.

So I’ll repeat what I said last time we were here:

Watch the important support levels closely and choose your buy points carefully. Be patient. Accumulate your favorite long positions-and a few shorts for good measure, like SKF and FXP-gradually. And then hold them and hold on.

I say that’s still the right call, and I’m sticking by it. Absolutely nothing has changed in the fundamentals for energy and commodities, and I believe the Street is severely overestimating the demand destruction factor.

When nobody wants to be in the sector, that’s when you want to buy it.

I mean, seriously: When a stock like ACI is down 14% in a day, that’s a golden buying opportunity. And gold, oil and natural gas at current levels are positively cheap.

So seize this opportunity accumulate a little more, and just sit tight. In another day or a week or three, you’ll be glad you did. Hold those positions for a year or two, as any good long-term investor would, and I guarantee you will make some good money on them.

In fact, you and other investors in energy and commodities might well be the only ones with gains to show for the period.

Until next time,

Chris

P.S. We have picked out some real best-of-breed and off-the-radar winners in energy, which we make available to subscribers of the $20 Trillion Report. If you want the inside scoop on them, sign up here.

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