Tale of Two Commodities

As I have been trying to figure out how to put my thoughts on the current state of the global commodities markets, this article by Jason Schwarz, of Loan Peak Asset Management, did an excellent job of describing where I am right now on this issue. 

I don’t necessarily concur with everything in the article and I probably wouldn’t be totally in line with what I perceive is the author’s views; however, his points breaking down the basic numbers and speculation around global commodities are very accurate. 

There is also a telling story about the economic fundamentals of this space in the market, which are well-said in the opening comment: 

What is the driving force behind the surge in commodities? If it’s a supply and demand issue than the rally in gold, oil, and agricultural companies like Monsanto (MON) and Agrium (AGU) is for real. If not, than this rally won’t last.

I am convinced now, however, that in this current market we cannot keep referring to the commodity markets in general – there is some breakdown and separation warranted, especially if we want to start talking about possible bubbles.  Let me explain … the direction of agriculture is not following the same long-term forecast trends as say energy.  If we want to start talking bubbles, then I assume we’re talking energy, or specifically oil.  If we’re talking commodities in general, I don’t think there is an economic dataset out there yet that can legitimately argue for a bubble.

Let me address oil separately though.  I was short-term bearish on oil just two months (or so) ago.  As it had significant price declines, I switched directions and have been cautiously bullish.  My price target on oil, as I have said before, is $125 a barrel.  I do think a bubble, albeit a small one, is forming around oil for the short term, and I believe that once we get into the $120-$125 range, we’re going to see higher volatility that will ultimately end in a burst, causing the price to go back down to the $85-$90 range.  When will this happen, you ask?  That’s the big question.  I can speculate and say this summer, but that’s not worth very much. 

The above referenced article hits the nail on the head in addressing some of the economic fundamentals and numbers around oil.  Don’t be fooled by talks of shortages and demand problems.  Sure, there are always daily fluctuations in supply and disruptions caused by strikes in Nigeria or boats in Iran, but these, in my opinion, are still just products of speculation.  These disruptions do not have significant affects on the long-term supply of oil (typically, at least). 

What is important and what does directly affect the long-term supply of crude are the discoveries of new fields and pockets of valuable oil throughout the world everyday.  Schwarz mentions the Gulf of Mexico, Utah, Brazil, etc.  He doesn’t mention the activity in Mexico, new fields throughout Sub-Saharan Africa, developments offshore in the Black Sea, and the list goes on.  Asia is our best friend, because we’re going to have to consume if we want any sort of volatility to remain.

Now, let’s move on to the other area of commodities that I would like to consider:  Agriculture.  This is a component of the commodities market that, in my opinion, should be set aside from energy.  The economic data for ag is much different than for that of crude and energy in general.  The discussion around food shortages is only the beginning of where this is going.  There is an overlying issue of the supply of certain vital food commodities going lower and lower. 

We also have a growing variable that will continue to consume corn, but drive consumption away from the consumers that need it most and that is ethanol.  As ethanol becomes more popular and as we continue to use a much needed food source for an energy source that no one really cares about at this point, the numbers will only continue to work against us.  The prices will continue to rise as supply declines, and we will only continue to see agriculture related commodities increase for the near term. 

So, we almost have a story of two different commodity markets with a world of different variables to consider within each.  What the outcome will be for each, of course I have no real clue, except to say that I can speculate all day long, but no one will really no for a while longer.  However, my strategy right now is to hold out on oil until we have more information once it moves within my volatility range and then will probably move out completely.  I am also looking for the best route on agriculture, but more on that later …

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