The sell off in commodities over the last two weeks has investors re-thinking the markets. Commodity stocks, especially in the energy area, have led the markets for over a year. Will this pull back in the commodity sphere prove temporary and shallow or is there something deeper afoot?
No question, most commodities have suffered a serious set-back led by silver, which at its worst, experienced a 25% decline before bouncing later this week. Oil also dropped over 13% and a long list of hard and soft commodities had similar declines. This selling spree has dragged the stock market with it.
“That makes absolutely no sense,” argues one Bennington,VT client who rightfully believes that declining prices for commodities is a good thing for the economy, the consumer, corporations and the market.
Yes, I agree there is a disconnect right now between the market and the economy over this issue, but remember that energy, metals, food and other commodity-related stocks have bolstered the markets. Most of the industrial sectors stocks (think Dow Jones Industrials) have also risen on the back of the rampant speculation in the commodity pits. Please see this week’s column “A Windfall in Disguise” for more on the causes and results of this speculation.
Readers may recall that I had put a “sell” on silver, gold and oil when the silver price reached $36-$37/ ounce and oil at $100/BBL. That was almost two months ago. I expected to leave money on the table in that trade, (since silver moved to almost $50/ounce and oil to $112/bbl.) but that was okay with me. I have always erred on the side of conservatism when investing in commodities. I also believe the selling is not over. I’m looking for silver to rebound to $40/ounce (a dead cat bounce) before crashing to the mid-$20. I expect oil to settle somewhere around $85/BBL.from its present price of $99/BBL.,which is where I see fair value.
In my experience, once a commodity has suffered a decline as sharp and as deep as the recent slide in silver or oil, it will take a period of time or “consolidation” before these commodities are ready to move higher once again. That period can be as short as three months or as long as a year or more.
Most commodities right now are still in an uptrend, at least technically. If prices continue to decline and break that uptrend, then the entire commodity space may relinquish their role as market leaders. If so, the stocks in that area may, at best, perform in line with the markets and at worst constitute “dead money” for a period of time.
I am still a believer in the fundamental growth story of commodities since the global supply and demand equation still favors the growing consumption of most commodities, especially energy and food. However, the rapid gains of the past may slow to a more moderate pace. In the meantime, investors would be advised to look at some alternative areas that might benefit from “sector rotation.” As investors sell yesterday’s winners, and move into tomorrow’s possible market leaders, health care, consumer durables, utilities and technology come to mind as fertile areas for new investment.
As for the market, last week I re-iterated that the S&P 500 Index would most likely bottom somewhere in the 1,305-1,325 range. I may be too negative in my forecast but better safe than sorry. I’m still expecting the market to make additional gains in the weeks ahead.