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Commodities: Has the Slide Ended?
New York: October 24, 2011
By John Stephenson

The prospect that European leaders are moving closer to a deal to contain the region's debt crisis helped spur a rally in commodities. Copper and oil moved sharply higher at the end of the week as European finance ministers started a six-day negotiation over how best to save Greece from default. Investors snapped up commodities that had been on a downward slide, ignoring the high-stakes deadlock that had developed between France and Germany over how to fund the European Financial Stability Facility (EFSF).

The rift that has developed between Europe's two leading economies is how to expand and finance the €440 billion EFSF. The goal remains the same: namely, to craft a comprehensive solution to Europe's debt crisis in time for a G20 meeting in Cannes in early November. France would like to turn the EFSF into a bank and boost its firepower with the financial backing of the European Central Bank, while Germany flatly rejects this idea. With time running out to find common ground, the Franco/German divide has pushed Europe once more towards the brink.

Moody's has warned of a possible reduction in the outlook for France's AAA rating from stable to negative, citing that France has government debt metrics “which are now among the weakest of France's triple-A peers.” Bond markets have responded to France's deteriorating financial health by pushing French 10-year yields up versus German Bunds to as high as 113 basis points—a euro-area record.

But for now, most investors seem willing to look past Europe's problems, believing that somehow, Europe will find the necessary resources to deal with the mess on their periphery. And that hope, coupled with a slew of positive economic indicators out of the U.S., has helped buoy the fortunes of stocks. Also helping to light a fire under U.S. equities is the Fed's operation twist and comments from various Fed officials that have signaled the likelihood of further accommodative monetary policy. Just last week, Federal Reserve Vice Chairman Janet Yellen said a third round of large-scale securities purchases might become warranted to boost an economy challenged by high unemployment and financial turmoil.

With corporate earnings remaining strong and hints from various Fed officials that U.S. monetary policy is likely to remain in unprecedented territory for quite some time, equities have staged an impressive comeback. Now, commodities are beginning to move higher. But for the move in commodities to be sustained, supply and demand have to remain out of whack. Luckily, for commodity investors, that's increasingly the case.

Copper has staged an impressive comeback, jumping the most in two years as European finance officials signed off on a €5.8 billion loan to Greece — helping to advert an immediate crisis. Oil prices surged last week, despite some early speculation that Muammar Qaddafi's death will increase Libyan output. But while the potential for Libya to boost oil output very meaningfully exists, increasingly analysts believe that the ramp up to full production will be slower, rather than faster. Oil workers and foreign companies fled Libya this year as the rebellion against Qaddafi's 42-year reign spread. The rebellion caused Libyan oil output to drop by 97 percent to a mere 45,000 barrels a day by August, increasing the economic chokehold on the country. And while the interim government is promising to lure foreign companies back quickly to ramp up production, this may be wishful thinking. There is no guarantee that existing oil contracts will be honored by Libya's new government and the country needs to replace badly damaged oil infrastructure and deal with tribal differences before the international oil community can return.

Also boosting the fortunes for oil investors has been the bullish commentary from the Paris-based International Energy Agency (IEA). Last week, they warned that the world faces a “dire” future if the problem of surging energy demand is ignored. The IEA forecasts a leap in global energy demand of more than 35 percent by 2035, with more than 90 percent of the increase in demand coming from emerging markets. Only massive investments by the energy industry will keep the price of oil from skyrocketing according to the last IEA report. By the agency's estimates, the international energy industry will need to invest some $38 trillion to meet the anticipated global energy needs without a massive surge in price.

With supply struggling and easy U.S. monetary conditions the norm, oil prices are set to move higher in the months ahead. Oil companies, who have seen their trading multiples collapse in recent months, look like another sure-fire winner in the weeks ahead as Europe's worries fade and the fundamentals for commodities have only strengthened.

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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