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Markets: Commodities
New York: March 01, 2004
By John R. Stephenson
Lately, something unusual has been happening in commodity
land. Prices have been going up! It wasn’t all that
long ago, in the go-go nineties, that commodity prices were
thought to be going nowhere as the “new economy”
boasted a world of strong productivity growth coupled with
low inflation. Today, with the specter of disinflation looming,
commodities appear to be one of the few investing bright lights
out there.
Gold is at a seven year high and one of the stalwarts of
the commodity world, copper, is also trading at a thirty month
high, not to mention that both natural gas and crude oil are
trading at price levels rarely seen before. The very word
commodity used to conjure up images of products and services
that were undifferentiated and therefore doomed to lower and
lower margins and prices.
Historically, the rise in base commodity prices such as nickel
and copper has foreshadowed improving economic conditions.
The Asian economies, where most of the manufacturing is being
done these days, appears to be chugging along at a reasonable
clip helping to drive the base metal commodity prices upward.
This, coupled with a sagging dollar, the currency in which
most commodities are quoted, is another factor underlying
the increase in commodity prices. Lastly, we are in uncertain
economic times and physical commodities offer something that
stocks and bonds don’t offer – tangibility. Commodities
are physical things that can be touched and stored in uncertain
times they offer a refuge to suppliers, end-users and speculators
alike.
The situation with energy commodities is somewhat different.
Oil has maintained its price strength in large part because
of the aggressive action on the part of OPEC – a cartel
whose mission is to optimize the economics of oil for the
benefit of the member states. The situation with natural gas
reflects fundamental changes that have been witnessed in the
producing regions as a result of the continued degradation
of the natural gas reservoirs in North America. As a result
of these fundamental changes in the deliverability of natural
gas, it is unlikely that we will see reduced prices for this
commodity anytime soon. Oil pricing continues to reflect the
geopolitical risks associated with drilling for a commodity
in regions of the world that have historically been less stable
and democratic than the previous supply basins (e.g. North
America and Western Europe) as well as a concerted effort
by OPEC to keep prices elevated. My long-term outlook for
oil pricing is for pricing to fall to the mid twenties and
remain there for the foreseeable future.
The situation for base metal commodities (those commodities
that are used in manufacturing) could be a different story.
As manufacturing activity picks up, commodity prices tend
to pick up as well. As commodity prices become elevated, marginal
production comes on to the market and helps distort the supply/demand
balance and causes prices to start heading lower. For clues
as to whether there will be a further strengthening in commodity
prices, look for an increase in economic activity or a further
weakening in the U.S. dollar. Look for commodity prices to
stay stable and possibly increase slightly through to the
second quarter of 2004. If the recovery continues, look for
commodity prices to start heading lower.
Figure 1: Commodity Prices
Figure 2: Natural Gas Prices
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