By Martin Hutchinson
In normal recessions, commodities prices fall – and stay down for the count – as mines, farms and oil wells continue to expand production, even as demand is flattened by the economic malaise.
Well, not this time around. And that figures to make commodities a profitable defensive investment. Indeed, we've uncovered four of the very best ways to profit from this trend.
Let me explain.
The Journal of Commerce commodities price index leaped 9.5% in May, the largest one-month gain since the index was first compiled back in 1985. Oil prices, which bottomed in the $30-a-barrel range, are pushing once again towards $70 a barrel – not the all-time record of $147 touched last year, but still very high on a historical basis. And gold is trading at roughly $980, close to its all-time peak and extremely high by historical standards.
So what's going on with commodities? And how can we, as investors, make money out of whatever it is that we're watching unfold?
This recession differs from traditional recessions – even global ones – in three ways:
- First, governments have been much more aggressive in implementing "stimulus" packages, and are running much larger budget deficits than was traditionally thought acceptable.
- Second, monetary authorities have expanded the money supply much more aggressively, holding short-term interest rates negative in real terms and operating proactively in the market to buy government bonds and other assets.
- And third, previous recessions haven't involved the nationalizations of major players – as we've seen this time around with General Motors Corp. (NYSE: GM) and Chrysler LLC. By contrast, the 1979 Chrysler Corp. bailout was almost entirely debt-oriented, with no government control. However, the economic effects of these latest nationalizations are both diffuse and long-term, with no obvious investment implications.
Banking crises have happened before – the worldwide crisis of 1931 serving as perhaps the most notable example – but they did not cause commodity prices to soar, nor is there any reason why they should have.
That brings us to the bottom line: It is very clear that the two unique features of this downturn that have strengthened commodity prices are the global budget deficits and the global monetary stimulus.
The St. Louis Fed's Money of Zero Maturity (MZM), the best measure of the broad U.S. money supply available since the U.S. Federal Reserve ceased reporting M3 in 2006, is up 10.8% in the past year and has advanced at a rate of 15.7% in the last 6 months – noteworthy when economic growth has been zero or even negative, and when the annual inflation rate has been running at no more than 2% to 3%.
Similarly, M2 is up 9% in the last year, while the narrow monetary base is up no less than 108%. You don't have to be a fanatical monetarist to expect these rapid rises to show up somewhere in the form of higher prices. Since house prices are falling and workers in a recession have little bargaining power, commodity prices are the obvious place for the monetary growth to appear.
Government stimulus, by creating artificial consumption, also creates artificial commodity demand. You only need to think of China's $586 billion stimulus plan, $100 billion of which is being spent on railroads, to understand the real effect on commodity output.
It's actually a simple equation: Government spending – at least in the form of infrastructure – requires a lot more steel, cement and other material commodities than private consumption of, say, video games. Even social programs and transfer payments to the unemployed give money to poor people, who are more likely to spend it than the rich. While private investment is depressed, large budget deficits can be financed fairly easily, and while this is occurring, commodity prices will be artificially strengthened.
As an investor, it is thus clear what to buy. Consumer-goods companies – particularly luxury consumer goods companies – will be somewhat depressed, while infrastructure providers and commodity producers will enjoy prosperity. Some ideas include:
- The Powershares DB Base Metals ETF (NYSE: DBB), which tracks the Deutsche Bank AG (NYSE: DB) base metals index, thereby allowing you to invest directly in the price movements of non-precious metals. With a market capitalization of $184 million, this ETF it is at least reasonably liquid.
- Suncor Energy Inc. (NYSE: SU), which is the premier producer of oil from Canada's Athabasca Tar Sands, which contain more oil than the Middle East, but are only economically attractive when the oil price is above $50 per barrel or so. Overpriced based on past earnings, but a highly leveraged play on further rises in the oil price, without the political risk of the Middle East.
- Companhia Vale do Rio Doce (NYSE ADR: VALE), Brazil's largest iron ore producer, and a key supplier to China's exuberant infrastructure expansion. China is trying to get a price reduction on iron ore imports that would represent a cut of more than 35% from the 2008 peak; my guess is that they will not succeed and .
- iShares Silver trust (Amex: SLV), which invests directly in silver bullion, whose price has somewhat lagged that of gold, and which can be expected to move up as gold does – and possibly even by a rather greater percentage.
That's four ideas – two direct and two indirect commodity plays – all leveraged to the current trend of rising energy and commodity prices, which doesn't seem likely to reverse anytime soon.
[Editor's Note:When the journalistic sleuths at Slate magazine recently set out to identify the stock-market guru who correctly predicted how far U.S. stocks would fall because of the global financial crisis, the respected "e-zine" concluded it was Martin Hutchinson who "called" the market bottom.
That discovery was no surprise to the readers of Money Morning – after all, Hutchinson has made a bevy of such savvy predictions since this publication was launched. Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives KO'd insurer American International Group Inc. He predicted the record run that gold made last year – back in 2007. Then, last fall – as Slate discovered – Hutchinson "called" the market bottom.
Now investors face an unpredictable stock market that's back-dropped by an uncertain economy. No matter. Hutchinson has developed a strategy that's tailor-made for such a directionless market, and that shows investors how to invest their way to "Permanent Wealth" using high-yielding dividend stocks, as well as gold. Just click here to find out about this strategy – or Hutchinson's new service, The Permanent Wealth Investor.]
News and Related Story Links:
- Money Morning Special Report:
Why Dividends and Gold Are the Keys to Permanent Wealth.
- Federal Reserve Bank of St. Louis:
- Money Morning Market Analysis:
Why Fed Policies and Treasury Department Bailouts Will Lead to Inflation Rather Than Deflation.
- Cambridge Press:
The Credit-Anstalt Crisis of 1931.
- Money Morning Investment Research Report:
Five Ways to Profit From China's $585 Billion Stimulus Plan.
- Money Morning News Analysis:
New Look General Electric Aims to Double its China Business by the Decade's End.
- Money Morning Special Report:
The Six Ways to Play Canada's Oil Sector.
- Business News Americas:
Analyst: Vale likely to accept 25%-35% iron ore price discount.
- Seeking Alpha:
Companhia Vale do Rio Doce (Vale) Q1 2009 Earnings Call Transcript.
- Yahoo! Finance/Morningstar: