The Commodities Bubble Hasn't Burst - It's Just Taking a Breather

Panicked investors retreated from silver, oil and copper this week, leading many to believe the commodities bubble had finally popped - but experts say this bull market will pick up again.

The Standard & Poor's GSCI Index that follows 24 raw materials fell as much as 11.4% in five days, the longest losing streak since August.

Some analysts believe concerns about a weakened economic recovery have spurred investors to take their commodity profits. However, others say this price slip is fear-driven and short term, and that key reasons to believe in a commodities bull run still exist.

[mm-toolbar]"It's panic," Michael Shaoul, chairman of Marketfield Asset Management, told Bloomberg News. "It's not a global financial crisis. It's a classic liquidation move in a crowded trade."

Crude oil fell about 15% this week. Oil for June delivery settled at $97.18 a barrel today (Friday) on the New York Mercantile Exchange (NYMEX). Copper fell about 6% to $3.95 per pound.

Silver fell 8% on Thursday on the Comex division of the NYMEX, its largest one-day percentage drop since Dec. 1, 2008. It's down nearly 30% this week.

This week's silver sell-off came after the metal hit a 31-year high of $48.58 an ounce last Friday, for a total year-to-date gain of 57%.

Prices halted their slide temporarily Friday after the non-farm payroll report showed payrolls increased last month by 244,000 workers - the biggest gain since May 2010. Some analysts said Friday's market activity showed that previously weak data did not mean the economic recovery was over.

"The panic that has ensued this week has been proven to be just that: panic," Alexander Ridgers, head of commodities at CMD Markets in London, told Bloomberg. "We have seen strong payrolls."

Panic Drives Profit-Taking

Some uncertainty is rooted in the fact that no one knows for sure what will happen when the U.S. Federal Reserve's quantitative easing policy ends in June.

"The reality of the end of QE2 is settling in, and there's some realistic profit-taking after an ambitious run up," said Money Morning Contributing Editor Peter Krauth. "With the relentless gains we've had, 'sell in May' may apply even more this year than in previous ones."

Money Morning Chief Investment Strategist Keith Fitz-Gerald said that while economic data is part of the story, there's much more to it.

"Traders are taking profits and don't want to be the last ones out of the game - that drives prices down," he said. "This is partly driven by concerns and rumors that margins will be raised on non-deliverable oil contracts in an effort to control speculation, similar to what just took the gas out of silver markets."

The Comex division of the NYMEX has raised margin requirements for trading silver futures 84% in the past two weeks. The move forced many individual investors to liquidate their holdings, driving down trading of the white metal.

Silver took another hit when several high profile investors like George Soros and John Burbank started selling their silver holdings. This put fear in investors' minds that the silver bull had run its course, leading many to follow suit.

The U.S. dollar's performance this week also was a factor. The U.S. Dollar Index, which compares the dollar's value to a basket of foreign currencies, rose from about 73 Monday to almost 75 on Friday.

"A big contributor to the sell-off in commodities is the bounce in the U.S. dollar," said Krauth. "All commodities are priced in USD. When it falls, it takes more to buy the same quantity of commodity. When it rises, as it's been doing for the last couple of days, commodities weaken, as it takes fewer dollars to buy them."

Fundamentals for Bullish Outlook Still Exist

Many analysts predicted commodities would hit a price correction at some point, but that this short-term pullback could present a great buying opportunity instead of a reason to get out of commodities for good. Even though the current high prices may be losing some air, they'll be headed to new highs again.

"If you're already exposed to commodities, don't sweat it, just mind your trailing stops," said Krauth. "If you're not yet invested, look for some further weakness and then take a position. The bull run is likely to last at least a decade still."

Goldman Sachs Group Inc. (NYSE: GS) said Friday that oil could surpass recent highs by 2012 due to supply strain, and that this week's pullback is a short-term trend.

"We continue to believe that the oil supply-demand fundamentals will tighten further over the course of this year, and likely reach critically tight levels by early next year should Libyan oil supplies remain off the market," Goldman analysts wrote in a research note.

Dr. Kent Moors, Money Morning contributing writer and editor of The Oil & Energy Investor, said this week's oil price slide does not mean the market environment is any different than before.

"This is the really important point: market dynamics have not changed at all; neither has trajectory or forward trends," said Moors. "The price of crude oil will still be increasing. A $150-a-barrel price may be delayed for a bit because of the 'correction,' but nothing has changed."

Money Morning's Krauth said a key sign of the long-term rise in commodities is the Continuous Commodity Index (CCI).

"For me, the CCI is the best overall indicator of the demand for commodities," said Krauth. "As you can see from the accompanying chart, it recently surpassed its previous high set in July 2008. While it has backed off somewhat in the last few weeks, it's still at historically high levels."

As for when commodities will rebound, Krauth said doubts surrounding the Fed's policy actions could keep prices low into the summer.

"It's not unreasonable to expect the CCI to drop back to the 600 or even the 550 mark as it's rather stretched above its 200-day level and could stand a breather at this point," Krauth said. "I think we could see a rebound as early as late summer, as the Fed starts reinvesting maturing securities into newly minted treasuries. Although less aggressive than the current QE2, that will keep fanning inflation in addition to the ongoing fundamental demand for raw materials."

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