The End Of The Commodities Bull? – Far From It!

Article by Fat Prophets

It’s no secret that the modern-day financial market goliaths, known as leveraged hedge funds, are selling billions of dollars worth of commodities investments to meet their redemption demands. This represents another severe short-term factor that is helping to drive down the prices of most commodities. The other major factor is the rising value of the US dollar, seemingly against all odds and good sense.

Adding to the downward pressure on commodities and resource-related companies are rumours that some hedge funds are aggressively short-selling the stocks that are in the portfolios of their vulnerable peers, which is sending share prices even lower.Of course, these hedge fund sharks don’t care about fundamentals or portfolio turnover. They are simply in the game for a quick profit. On the other hand, at Fat Prophets we are greatly concerned by fundamentals and in our view the longer-term fundamentals for the resource sector remain healthy.

Resource stocks are trading at very low price-to-earnings ratios and at very large discounts to cash flow. As we have commented previously, different commodities rotate in leadership each year; however, long-term supply constraints have not disappeared and demand from global infrastructure spending continues to remain robust.

We agree with Morgan Stanley’s global mining research that concludes that we are still in the early to middle years of a commodities super-cycle, on which we’ll go into more detail later. On the gold and oil oscillators above, it appears that those two natural resources are deeply oversold, and the same holds for the equities linked to these resources. The rising value of the US dollar has also contributed to the recent decline in the price of commodities and commodity stocks. According to research from US Global Investors and Morgan Stanley, the dollar is up more than two standard deviations over the past 60 trading days. As you can see on the dollar chart above, this has happened only a handful of times during the past decade.

You will also note that once the US dollar is up two standard deviations, it usually reverses direction and starts correcting to the mean long-term price. If the current rally follows that pattern, we could soon see the dollar again losing value, which would be supportive of oil, gold and other commodities. The chart above from Morgan Stanley goes back more than 200 years to show cyclical trends in commodities prices. What you notice is that the upswings tend to be sustained for long periods of time before retreating. These commodities super-cycles often last 20 to 25 years, according to Morgan Stanley’s research, and if this one follows the pattern, we have many years to go before it plays out. The key drivers are the rapid economic growth in China and infrastructure spending in other large emerging markets.However, whilst we’re in the midst of a super-cycle, there are periods of short-term volatility that can be caused by any variety of factors, among them supply and demand issues, governmental policies and market sentiment. During this time, any single commodity can swing wildly from year to year, even during a strong bull market.Infrastructure spending is the foundation of future commodities demand. As the CEOs of two of the world’s biggest resource companies have confirmed in recent weeks with positive comments on China, we are looking at strong and steady growth in infrastructure spending over the next decade. Most of the billions to be spent will be on the building of roads, airports, power generation and the like in Asia, followed by Russia and Eastern Europe, and Latin America.

Returning to the leveraged hedge funds for a moment, they are not the only reason for the current volatility in commodities markets. There has also been reduced demand for these resources and worries linger about the tender state of the US economy and the prospects of a deep global economic slowdown.

While we remain bullish from a longer-term perspective, we are also not ignoring these short-term headwinds in our outlook. Accordingly, we are actively reviewing our positions, as the current environment means smaller situations are likely to struggle. At the same time though, there are opportunities amongst mid to larger-cap companies that we never thought would present themselves.

We remain optimistic about the longer-term picture for commodities, however the short-term will be characterised by volatility related to ongoing uncertainty with respect to financial markets and credit worries emanating from the US. Longer-term, commodity supplies remain tight and as global demand inexorably increases in line with population growth, price rises for both commodities and resource companies will reflect this.

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