Fueled by low inventories, healthy economic growth and surging global liquidity, the commodities markets are registering some of their largest price gains since the 1970s.
And the price rises are not concentrated in just a few areas, but have been rising pretty much across the board.
Grains, crude oil, gasoline, lumber, copper and most industrial commodities have all reached multiyear highs recently. The Knight-Ridder Commodity Research Bureau Index, probably the most closely watched indicator of commodity prices, is rocketing toward a 10-year peak.
“We are seeing the end of a 15-year bear market in commodities,” says Bill O’Grady, commodities analyst at A.G. Edwards in St. Louis.
After wallowing in the doldrums for most of the 1980s, commodities do seem to have broken out in earnest. But after so many false starts in recent years, many are reluctant to believe in the nascent commodities bull market, calling it a “sucker’s rally.”
But Bill Sullivan, economist at Dean Witter Reynolds in New York, says there are some compelling reasons to think that this time around the rally isn’t just for suckers. “For the first time in more than a decade you can make a good case for buying hard assets,” he says.
Economists say the most important factors underpinning the commodities rally are monetary liquidity and low commodity inventories.
The liquidity argument is very simple. Central banks in the world’s three largest economies have been printing a lot of money. Monetary economists argue that the money value of commodities will tend to rise in this environment, because when the supply of money increases, it becomes relatively less valuable than tangible wealth.
That there is more money milling around the system there can be no doubt. Both the Bank of Japan and the U.S. Federal Reserve have massively lowered interest rates in the last few years, especially the Japanese. While the Germans have been much more circumspect about lowering rates, it’s only because they’ve had to be following a massive giveaway to East Germans during reunification in the early 1990s.
With all three of the world’s major economies pumping money into the system, analysts are far more inclined to view this rally in commodities as sustainable.
The other reason that the commodities rally may have more steam than in the 1980s has to do with historically low commodity inventories. Probably the clearest example of this is in the grain market, where stocks are near 50-year lows.
The reason commodity stockpiles are so low is because it was very unprofitable to hold on to commodities in the 1980s, when prices were not rising. Also, productive capacity in many cases shrank, or at least didn’t grow, because there was little incentive to invest in new output.
“Because prices were low for so long, there were big changes in production and consumption patterns,” says A.G. Edwards’ O’Grady.
O’Grady does not foresee a huge increase in commodity values like in the 1970s, but he does feel, along with many other analysts, that commodities will be rising for years to come. If you buy into the commodities bull market scenario, what then are the best ways to participate as an investor?
Investors should probably avoid buying commodities directly through the futures markets. Academic studies show that most small investors who buy futures, which are contracts to buy or sell a commodity at a specific price in the future, lose the entire value of their investment.
The main reason for this is that most commodity investments are highly leveraged, with many contracts requiring that the investor put down as little as 2 percent of the value of the contract. Because price swings can be quite dramatic day to day, it doesn’t take much to get wiped out. Commodity futures are, in other words, a professional’s market.
A far better way to participate, and perhaps even more profitable in today’s environment, is to buy the stock of companies in industries that will benefit from a bullish commodities environment.
One such industry is the gasoline refinery business. While gasoline futures are up a healthy 13 percent or so from last year’s levels, refining stocks have soared much higher. The shares of Tosco Inc., a refiner, have jumped by nearly 100 percent over the past 12 months.
Analysts continue to be bullish on gasoline refining stocks, citing the fact that there has been virtually no increase in capacity in recent years. A congressional study found that the last refinery construction in the U.S. occurred more than 20 years ago.
“We have some very fundamental changes occurring in the commodities-oriented businesses,” says Dean Witter’s Sullivan. “This is especially true of energy and refining.”
Sullivan says that one of the key shifts occurring with respect to gasoline is that the American vehicles has become less fuel efficient. When combined with big increases in the speed limit nationwide, this is going to mean big increases in gas consumption.
Despite President Clinton’s recent attempt to dampen price rises by releasing supplies from the nation’s strategic reserve, analysts say that increases in gasoline consumption and refining capacity constraints add up to excellent profits for refiners.
Top refinery recommendations among analysts include Diamond Shamrock and Ultramar.
Oil companies, which learned to make money on razor-thin margins in the 1980s, are now seeing those margins explode because of higher oil prices. All of the majors, most notably Amoco and Texaco, saw double-digit earnings growth in the first quarter.
Charles Maxwell, oil analyst at C.J. Lawrence in New York, sees 25 percent earnings gains in store for Penzoil and USX Marathon. He expects both stocks to rise 25 percent over the next year.
Mutual funds that are exposed to natural resource stocks are up 18 percent this year, a gain that far exceeds the 10 percent or so gain in the CRB index over the past year. Natural resource funds that have done well include T. Rowe Price New Era and Prudential Global Natural Resources.
