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Commodity Investing Shell Shocked
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Markets: Commodities
New York: March 01, 2004
By John R. Stephenson

Lately, something unusual has been happening in commodity land. Prices have been going up! It wasn’t all that long ago, in the go-go nineties, that commodity prices were thought to be going nowhere as the “new economy” boasted a world of strong productivity growth coupled with low inflation. Today, with the specter of disinflation looming, commodities appear to be one of the few investing bright lights out there.

Gold is at a seven year high and one of the stalwarts of the commodity world, copper, is also trading at a thirty month high, not to mention that both natural gas and crude oil are trading at price levels rarely seen before. The very word commodity used to conjure up images of products and services that were undifferentiated and therefore doomed to lower and lower margins and prices.

Historically, the rise in base commodity prices such as nickel and copper has foreshadowed improving economic conditions. The Asian economies, where most of the manufacturing is being done these days, appears to be chugging along at a reasonable clip helping to drive the base metal commodity prices upward. This, coupled with a sagging dollar, the currency in which most commodities are quoted, is another factor underlying the increase in commodity prices. Lastly, we are in uncertain economic times and physical commodities offer something that stocks and bonds don’t offer – tangibility. Commodities are physical things that can be touched and stored in uncertain times they offer a refuge to suppliers, end-users and speculators alike.

The situation with energy commodities is somewhat different. Oil has maintained its price strength in large part because of the aggressive action on the part of OPEC – a cartel whose mission is to optimize the economics of oil for the benefit of the member states. The situation with natural gas reflects fundamental changes that have been witnessed in the producing regions as a result of the continued degradation of the natural gas reservoirs in North America. As a result of these fundamental changes in the deliverability of natural gas, it is unlikely that we will see reduced prices for this commodity anytime soon. Oil pricing continues to reflect the geopolitical risks associated with drilling for a commodity in regions of the world that have historically been less stable and democratic than the previous supply basins (e.g. North America and Western Europe) as well as a concerted effort by OPEC to keep prices elevated. My long-term outlook for oil pricing is for pricing to fall to the mid twenties and remain there for the foreseeable future.

The situation for base metal commodities (those commodities that are used in manufacturing) could be a different story. As manufacturing activity picks up, commodity prices tend to pick up as well. As commodity prices become elevated, marginal production comes on to the market and helps distort the supply/demand balance and causes prices to start heading lower. For clues as to whether there will be a further strengthening in commodity prices, look for an increase in economic activity or a further weakening in the U.S. dollar. Look for commodity prices to stay stable and possibly increase slightly through to the second quarter of 2004. If the recovery continues, look for commodity prices to start heading lower.

Figure 1: Commodity Prices

Figure 2: Natural Gas Prices

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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