Why I Still Like Commodities

This past month was one of the toughest I’ve had in the markets in quite some time. I know that is not unusual in any sense, as it was a tough month for most folks who were long common stocks. For me, it was particularly rough since I have been so much (too much?) overweight in energy and commodity stocks.

I just read where quite a few hedge funds gave up half their year to date gains over the past month due to the commodity correction. I have also seen quite a few articles recently on why oil and commodities are speculatively priced, are a bubble, and why they must come down. I think most of those articles are self-serving and wrong. There are always corrections in a bull market. In the world of commodities, those corrections can be particularly stunning in their viciousness. But, unless the economy goes in the tank, the odds favor this being just a correction in a longer term bull market, not the end of the commodities run.

In my opinion, the folks who are stock market bulls and commodity bears cannot have it both ways. If the economy and the markets are going to do well, then so will the commodity stocks. We are taught that when anyone says, “This time is different,” that we should immediately run the other way. Of course, many of the same folks who give that advice now did not recognize a bubble when it consisted of technology stocks in 2000.

But I believe this time is different. Every so often in history something comes along that changes everything forever. Electricity, machines, gunpowder, nuclear fission all come to mind as examples. The rise of the Asian countries, particularly China, may qualify as such an event. China has decided to become the world’s power. That requires all kinds of build ups in their nation’s infra-structure. That requires commodities. The rise of China, and to a lesser extent, India, the world’s two most populous countries will ensure that commodity prices stay overall higher, as there will be ever increasing demand chasing a more inelastic supply of natural resources.

Periodically we read where China’s growth is going to slow, but then we see a couple of months later that it did not. As I have said before, when I think of where China is right now, I think Germany 1936, when Hitler wanted to use the 1936 Olympic games to showcase his nation’s supremacy. China is hosting the 2008 Olympic Games. They want to become the world’s superpower. What are the chances they are not going to try and impress the world with their majesty and grandeur during the Olympics? That is going to require a continuing buildup of their infrastructure. And that is not even including all the resources they will need in other areas of their society to pursue their vision of world power.

This is the only scenario that makes sense to me UNLESS there is some event that truly does create demand destruction for the world’s natural resources. It is difficult to see how an event of that magnitude would also not take down the economy and the markets with it at the same time. So we’re back to square one. If the economy does well, then so will commodities.

Over the years I have learned that successful trading means blocking out as much of the noise as possible from Wall Street cheerleaders. There are some folks I have watched for years who have never seen a bad time to buy stocks. No matter what happens, it is a good time to buy something. Some of those folks are very well known and get a lot of tv time to espouse their gospel. Most permabulls do not like commodity stocks. The reason is simple. There is only so much money available for buying stocks. Every dollar that does into commodities does not go into the stocks they pump. Further, money that goes into commodities is, in a way, a vote against the permabull happyface mentality that Wall Street projects to the public.

Consider the source of the information you get (yes, including what you are reading right now. All decisions are ultimately yours.). If you went to a Chevy dealer for advice on buying a car, do you think he will direct you to the nearest Toyota dealership? Have you ever noticed that mutual fund oriented advice basically tells you that you cannot time the markets and that you cannot make your own investment decisions, that you should leave them to the professionals? Yet most commercials for the discount brokerages give you the exact opposite advice. You can do this, they say. And then there’s the full service brokers. You need to pay for their expertise, they tell you. It seems to me that most of the advice is predicated on the financial welfare of the party giving out that advice.

If the commodity stocks do not make a comeback fairly soon, I will be taking that as a canary in the mines warning. Be careful out there.