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Disco Days: The Commodity Bull Market Returns
New York: February 14, 2011
By John Stephenson

Increasingly, it\\\'s starting to look like the 1970s all over again—a period of time when commodities soared and stocks and bonds went nowhere. What many people remember about the 1970s was sky-high oil prices and long lines at gas stations. But there was more to the 1970s than soaring oil prices, food prices also rallied sharply and devastating famines wrecked havoc in poorer countries.

Today, food and fuel prices are once again marching higher and causing citizens to take to the streets in North Africa and the Middle East . And while North Americans have thus far been insulated from soaring food prices, food processing companies are starting to put through hefty price increases to preserve their margins in the face of skyrocketing food prices. Both PepsiCo and Kraft Foods Inc. have announced planned price increases for 2011 as corn prices have more than doubled in a year and other key foods are up sharply.

Rising food prices will help push Western central bankers to the wall in their conflicting efforts to spur economic growth, while at the same time, combating inflation. Further complicating matters is the fact that most western countries import their commodities—a circumstance that pits imported inflation against stagnating domestic economies. The challenge for central bankers will be to find a way to craft a path forward that addresses the growing inflationary pressures and yet manages to be stimulative—a massive challenge.

Rising food prices will help push Western central bankers to the wall in their conflicting efforts to spur economic growth, while at the same time, combating inflation. Further complicating matters is the fact that most western countries import their commodities—a circumstance that pits imported inflation against stagnating domestic economies. The challenge for central bankers will be to find a way to craft a path forward that addresses the growing inflationary pressures and yet manages to be stimulative—a massive challenge.

After the OPEC oil embargo of 1973 took effect, oil prices spiked, increasing fourfold, while the stock market crashed from late 1973 to 1974. By 1979, U.S. inflation had hit 13.3 percent and, in August of that year, Paul Volcker was appointed by U.S. president Jimmy Carter to serve as chairman of the Federal Reserve. Volcker got right to work, limiting the money supply that had been helping to fuel inflation throughout the 1970s. By ratcheting the benchmark federal funds rate up to a high of 20 percent in July 1981, he eventually was able to bring U.S. inflation down to 3.2 percent by 1983—a remarkable achievement.

Today, the circumstance that the West finds itself in is much worse. Inventories for food and other vital raw materials are depleted and huge government deficits and loose monetary policies are a potent combination that will likely continue to accelerate commodity inflation at a time of a very weak economic recovery in the rich world.

While economic growth in the West is solidly underway, it\\\'s being driven by the government sector rather than by corporations or consumers. The unemployment rate remains stubbornly high and consumers are sitting on their wallets, terrified of getting walloped again. Can the traditional investment mix of stocks, bonds, and real estate really be expected to outperform in this low-growth environment?

Nope. During the 1970s, commodities roared while stocks and bonds went nowhere. During that decade, America was strong, Europe was reemerging as an engine of global growth, and the economies of South Korea, Japan, and Taiwan were on the move. This time around, four-fifths of the world\\\'s population is emerging from an economic funk—creating hundreds of millions of new global consumers. Demand for commodities continues to surge. There are no substitutes for these critical feedstocks of industrialization and urbanization, and supply remains constrained.

With government and consumers in debt up to their eyeballs, the prospect of a slow-growing economy looks increasingly likely. This economic restraint will slow investment, profits, and payments to investors in the form of dividends and interest. As America, and much of the West, enters a slow-growth era, buying a basket of S&P stocks looks increasingly like a sucker\\\'s bet. Commodities, fueled by the fast-growing economies of Asia, should be the go-to sector over the next decade. Bell bottoms and disco may never stage a comeback, but we may be going back to an investment climate like the 1970s, when commodities soared and just about everything else tanked.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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