Select Page

Stock markets staged a strong rally yesterday, January 4, boosted by strength in commodities and commodity stocks.

The Standard & Poor’s 500 stock index climbed 1.6% and the Dow Jones Industrial Average was up 1.5%. Oil (West Texas Intermediate) climbed $2.15 a barrel to $81.51. Copper hit a 16-month high at $7,536 a metric ton. Lead soared by 2.9% and tin by 3.4%.

Is this—rising commodity prices powering a climbing stock market—a trend that you want to bet on in 2010? Or was yesterday’s rally in commodity prices a one-day wonder?

Somewhere in between, I’d say.

The short-term forces pushing up commodity prices will last for more than a day. A run of months is possible.

But forecasts of another year-long run (or longer) from today’s already elevated price levels seems like wishful thinking.

My skepticism runs against the grain—or at least some of the grain–of a report from the International Monetary Fund (IMF). Commodity prices, the IMF said in a report (see it here ) released on December 30, 2009, will remain high by historical standards in the long term as emerging economies industrialize and in the short-term as the global economy expands at a faster pace in 2010.

I agree with the IMF’s conclusions for the long-term: I think growth in China, India, Brazil, Viet Nam, and other developing economies will keep demand close enough to supply to keep commodity prices climbing over the next decade.  

It’s the short-term conclusion that I’ve got to differ with.

 2009 saw the biggest annual increases in commodity prices in four decades as prices rebounded from the lows of early 2009. The IMF’s commodity index climbed 40% in 2009 from the February 2009 low. But much of that rebound didn’t reflect current demand, which remains tepid for many commodities—oil for example. Instead those price increases anticipated a rebound in demand in late 2009 and 2010. And a lot of the buying that fed into those price increases was a result of inventory restocking by companies themselves anticipating a need for increased supplies of raw materials to meet higher orders from their customers.

Looking at current inventory levels at commodity consumers and current excess capacity at commodity producers, I can’t find the kind of constrained supply situation that would push up commodity prices at a hefty pace in the near term, say the rest of 2010.

The IMF report actually concedes this point, noting that commodity price gains in 2010 would be “moderate” due to above average inventories and substantial space output capacity.

A skeptic such as myself looking at Monday’s rally in commodities sees lots of very temporary forces at work to push up commodity prices. There was a cold wave in the United States that sent up oil prices on speculation about an increase in demand for heating oil. That same cold wave set off fears of further delays to the last stages of the corn harvest and of damage to the Florida orange crop that led to increased prices for corn and orange juice futures. A strike at Codelco, the world’s largest copper producer, produced higher copper prices. These all strike me as short-term events and not the basis for a big 2010 rally in commodity prices.

You can argue that these short-term events are merely evidence of longer-term imbalances of supply and demand. The Codelco strike wouldn’t be able to move copper prices so strongly if copper capacity wasn’t so tight, the bulls currently argue.

But to my way of thinking, to see a big commodity rally in 2010, you’ve got to believe in a scenario where economic growth in the United States is strong enough to increase global commodity demand but not strong enough to produce a Federal Reserve rate increase in 2010 since that would lead to a stronger dollar. Which would push down commodity prices.

To me that sounds like asking the financial markets to thread a pretty small needle. Not to say it can’t happen but the odds of it not happening are pretty good.

So it shouldn’t surprise you that the commodity markets are the scene of a hard-fought war right now. The consensus of analysts surveyed by Bloomberg calls for as much as a 17% increase in the prices of oil, corn, gold, and palladium in 2010. Goldman Sachs estimates that the S&P GSCI Enhanced Total Return Index of 24 commodities will gain 18% in 2010. Energy with a 25% gain and metals with a 15% gain will lead the index.

Investors put $60 billion into commodities through exchange traded funds (ETF) in 2009 according to Barclays Capital. A December survey of 250 investors by Barclays projects that investors will put at least that much into commodity ETFs in 2010.

Which has led some prominent money managers to take the other side of the trade. For example, Barton Biggs, the manager of Traxis Partners, is buying household-product stocks such as Procter & Gamble (PG) and shorting commodities.

Any big contrarian bet is a play on a stronger U.S. dollar. If the dollar continues its end of 2009 rally, 2010 will turn into a tough year for commodities.

With this much uncertainty and this much risk, I wouldn’t put big bets on a basket of commodities on either side. In 2010 I’d avoid commodities such as oil with abundant supply sitting on the sidelines and questionable demand growth. I’d take a pass at the highest flyers of 2009—lead was the best performing industrial metal in 2009 (up 143%) but is forecast to show a modest decline in price in 2010—and look for areas of tight supply that are likely to lead to sustainable price gains in 2010. Three areas to target, in my opinion, are iron ore (with annual price negotiations pointing to higher prices in 2010), fertilizer (with rising corn prices giving farmers more cash to put to work in their fields), and molybdenum (on rising auto global auto production.)