Matt McCall: The Outlook For Commodities

June 01, 2011

Matt McCall surveys what's hot and what's not in commodities for the rest of the quarter.

The Dow Jones UBS Commodity Index began the month of May at its best level in more than two years, with precious metals and energy leading the way. Fears of an economic slowdown and a rally in the U.S. dollar, however, have convinced many investors to lock in big profits. Over the last 30-plus days, the index decreased more than 5 percent.

The Corn Story

The price of corn has more than doubled in the past 12 months, rising from $3.35 to more than $7.50. The price of corn is heavily dependent on the U.S. because the country is the world’s largest producer of the grain as well as the largest exporter. But keep an eye on China: For the week ending May 20, the US Department of Agriculture (USDA) reported that U.S. exporters sold 116,800 metric tons of corn to China, the first reported sale of 2011. The sale took place earlier this spring.

If China, the No. 2 corn-consuming country, continues to demand more exports, it could be enough to help corn continue its rise to new highs. When the demand is coupled with supply issues due to adverse weather in the U.S., it appears to be the perfect storm for the grain, no pun intended.

The Teucrium Corn Fund (NYSEArca: CORN) is up 16 percent in 2011 and only 3 percent from the closing high in late April. Unfortunately, the storms in the Midwest do not appear to be slowing, which could lead to a below-average corn crop.

Silver Uh-Ho

Through the first four months of the year, the iShares Silver ETF (NYSEArca: SLV) gained 55 percent and the commodity was trading at its best levels in decades. But that is when it ran into a brick wall. Over the next two weeks, SLV lost 30 percent as investors rushed to the exits as the fear of a bursting bubble swept the globe.

I have been asked many times in the last month whether silver was in a “bubble,” but I continue to look at the situation with a longer-term view. Even with the precipitous drop in the month of May, investors who purchased SLV last year have more than doubled their initial investment. So if a label must be put on the metal, it could be considered a short-term bubble, but long term, the uptrend remains intact and the pullback is nothing more than a buying opportunity.

Black Gold

Similar to silver, oil also took a big hit during the month of May after the tensions in the Middle East and North Africa subsided. Coupled with the fear of a slowing global economy, that’s been enough to push the oil futures from $114 per barrel to $95 in a matter of days. Similar to silver, oil was due for a pullback, and when the selling began, it created a wave of profit-taking, and short-sellers entering the market.

The selling pushed the commodity back to support at $95, and over the last two weeks, that has been a great area in which to buy oil. One of the possible ETFs is the United States Oil Fund (NYSEArca: USO), which has a buy zone between $38 and $40 per share.

The Potential Pitfalls

The performance of most commodities is tied to the strength of the global economy as well as the supply situation. Two big potential roadblocks for the commodity bull market are the ongoing unknowns regarding Europe and more bailouts as well as the potentially slowing growth in China.

The European situation appears to be limited at this time to smaller, less significant countries that do not account for a sizable commodity demand. However, if the bailouts spread and it begins to affect the larger nations and even jumps the pond to the U.S., commodities will be hit very hard. As far as China, if growth slows to 7 to 8 percent, I am still happy with the demand they will contribute for commodities. This is more of a short-term concern.

The Bull Market Drivers

Along with simple economics (supply vs. demand), there are a plethora of other factors that could push prices higher on all commodities. One of the biggest drivers of commodity prices is the action in the U.S. dollar versus foreign currencies.

As the value of the US Dollar falls it allows more of the commodity to be bought by foreign countries. This is due to the fact that commodities are priced in U.S. dollars. Therefore, if the value of the U.S. dollar falls by 10 percent versus the euro, in theory, EU nations can purchase the same amount of oil at a 10 percent discount. This will increase demand and push up the price of oil.

After a 4.3 percent rally in the first three weeks of May, the US Dollar Index has begun to restart its long-term downtrend. This is a positive for commodities and a major reason the sector has been rallying into the end of May.

Patience For Commodities

Investors who invest in commodity ETFs are typically novices when it comes to owning gold or oil or corn. Often times they tend to lose money because they are chasing the “hot” commodity and buy too high and end up selling lower. When silver was hitting 30-year highs, my phone was ringing off the hook with individual investors wanting to know how they can buy silver. After the metal pulled back to a more attractive level, the phone stopped ringing. My point is that just as investing in equities takes patience, so does commodities. Use the charts and do you due diligence before chasing the next hot commodity.

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