Commodity Investors Cheered in 2007

By Kristina Zurla Landgraf   ISSUE 702 | FEB 2008

If you invested in commodities in 2007, your portfolio probably looked a lot different than that of the typical stock market investor. Last year started out upbeat for the equity markets, but by year-end, subprime lending woes took a toll, and the major market averages were lucky to escape 2007 with single-digit gains. The sour mood has continued into 2008, and expectations for this year are mediocre at best. For commodities, the story was much different—last year saw historic price booms in a variety of physical assets, and some say the commodity boom will continue this year.

The S&P rose 3.5 percent in 2007. Compare that with soybeans, up 77 percent last year, crude oil, up 57 percent, corn, up 17 percent, and gold, up 30 percent. Broad-based commodity indexes also outperformed equity benchmarks. The Dow Jones AIG Index, which is made up of a basket of 19 different commodities, rose 11 percent last year, and the CRB CCI Index, which is made up of 17 commodities, rose more than 19 percent.

Commodity demand is expected to increase in growing nations like China and India, and the need for alternative fuel sources has also fueled a bio-boom in agriculture. The weakening U.S. dollar, egged on by a series of interest rate cuts from the Federal Reserve, also gave commodities a big boost. Many commodities are priced in dollars, and a weaker dollar makes them more attractive to global market participants, fueling price increases. Last year, the Fed started a series of reductions in its key short-term lending rate, the Fed funds rate, bringing it down from 5.25 percent in August 2007 to 3 percent by the end of January 2008. Just look at a chart of the Fed funds rate when rates started dropping in the second half of 2007, and compare that with the chart of corn futures, which rallied during that time, as an example.

Will the Commodity Boom Continue?

Will the commodity boom continue this year? Many professionals say yes. In a recent Fortune magazine interview, famed commodities trader and author Jim Rogers, who co-founded the Quantum fund with George Soros back in the 1970s, said that "the fundamentals of the secular bull market in commodities are not over." There has been growing concern an economic recession will dampen demand for many commodities, causing some corrective moves, and volatile market swings. But Rogers said the price pullbacks on recession fears haven't dampened his enthusiasm for many commodity markets, particularly agriculture. And, he saw a strong possibility of stagflation—no economic growth, combined with inflation that would keep prices high.

Lind Plus Senior Market Strategist Richard Ilczyszyn said even some of his farmer clients can't believe the prices grains are commanding. "Beans in the teens" was a catchphrase that became real as soybean futures crossed $13 a bushel in January 2008, passing the prior peak set in 1973. Given that the U.S. Agriculture Department sees world soybean inventories falling 23 percent in the 2007-2008 season, there may be more room to rally.

Wheat in the teens has also become reality. After a USDA report on February 8 predicted the lowest inventory levels in 60 years, futures surged to record highs in the three markets where it's traded, Chicago, Kansas City and Minneapolis, and saw a string of daily limit-up moves. Spring wheat, traded in Minneapolis, crossed $20 a bushel in late February.

"We are stepping into a new era," said Ilczyszyn. He said we could see many agricultural commodity prices rise five to 10 percent more this year, and thinks gold will reach $1,000 an ounce by spring. He also thinks crude oil is more likely to retest its highs than its lows as we head into this year's driving season. Even so, Ilczyszyn said investors should be leery of chasing tops in these markets, because it's likely to be a volatile year, and corrections could be severe. "If you are buying, beware. Once gold does hit $1,000, we could see a swift collapse of $100 or more, he said." He recommends not getting married on one idea too long, trade small if you have to, and use proper risk management.

"If the Fed lowers interest rates enough, we will get inflation," said Lind Plus Senior Market Strategist Jeff Friedman. He sees the Fed lowering rates further, but should stop at a 2.50 percent or possibly 2 percent Fed funds rate. For commodities, that means there is room for further gains. Gold has been in a bull market four years, and will face some dips accordingly, he said. He recommends not only keeping an eye on interest rates, but watch action in the dollar too if you trade commodities.

"For now, I'd recommend buying dips in gold but would play the bull market in a trading range from $850 to $940," said Friedman. Gold could correct down to $825, but it is still being viewed as a safe haven, and is being treated as a third currency, he said. "Sure, there will be corrections, but I don't think the bull market is done," Friedman said, adding that if the Fed funds rate moves to 2.50 percent, look for gold to rally up to $1,000, crude oil could move back to $98, and corn should rise to $6 a bushel. If the rate moves to 2 percent, he sees gold potentially peaking at $1,150 and crude at $110, but it won't happen in an instant. It could take a few months to get there, then trends may start to change as the year progresses.

Friedman said by August, we'll be shifting gears from talk of recession, to tackling inflation. As we get closer to resolving some of the issues in the economy, and the Fed's rate cuts start to work their way through and create economic momentum, the stock market should pick up, and the commodity run could stall. "If people are afraid, as they are now, they'll slow their spending, and we'll see corrections in many markets. So once we get past that, we'll see what comes next," he said.

Richard Ilczyszyn can be reached at 800-605-0095 or via email at rilczyszyn@lind-waldock.com.

Jeffrey Friedman can be reached 866-231-7811 or via email at jfriedman@lind-waldock.com.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.

Futures trading involves substantial risk of loss and is not suitable for all investors.

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