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Commodity Futures

When talking about commodity futures, it is very easy for people to associate it with risks.  Yes, commodity futures trading involves greater risks than buying stocks.  However, we would like to inform you that we will experience a commodities bull market in the next decade or so. 

Here are the reasons:

20-Year Low Commodity Prices

One positive for commodity prices is the 20-year low in commodity prices. The last 20 years have been a bear market for commodities.  Formerly the biggest commodity brokerage company Merrill Lynch closed down its commodities trading department because of lack of interest from the general public in trading commodity futures. 

However, commodity prices follow a 35 to 40 year cycle, which leads to 17.5 to 20 year upward trend and 17.5 to 20 year down trend.  In fact, some commodities have already seen their prices go up in the last a few years or months, namely cocoa, crude oil, etc.

All these signs are signs of extreme pessimism in commodities would be signs of extreme optimism for contratrians

Demand from Asia for Commodities

Another positive for commodity prices is demand from Asia. The 1997 depression in Asia led to very weak demand for commodities; however, as Asia’s economies rise back, there will naturally be a strong rise in demand for all types of commodities as the region's economy grows.

There is also a strong correlation between the performance of emerging markets and the performance of commodity prices.

Demand from China

Another driver for commodity prices is China. China is one of the few countries in the world today with a steady, long-term high-growth rate. As Marc Faber mentions in his book “Tomorrow’s Gold” that “China will become the top consumer of Asian natural resources, send out Asia’s largest number of tourists, and invest heavily around the region in joint ventures or take over entire businesses.” Therefore, China’s demand for commodities is expected to escalate during the coming years. Marc Faber concludes on China: “In fact, I regard the purchase of a basket of commodities as the safest way to play the emergence of China as the world’s dominant economic power.”

According to our private investigations, China has already seen a shortage of some of the main commodities, namely steel, timber, oil, and others.  The continued growth of China's economy and the need for raw material supplies would definitely continue the trend, not reversing it.

US Dollar Depreciation

US Dollar depreciation is another factor for the rise of commodity prices.

US dollar is currently depreciating against all major currencies.  The trend is continuing and will be continued.  (Yes, the United States is the largest debtor nation in the world.)

With US dollar depreciating against other currencies, you can hedge yourself by buying currencies such as the Euro, Japanese Yen, British Sterling, Australian and New Zealand Dollar or Canadian Dollar.  Or better yet, you might want to hedge against a basket of commodities. This would mean commodity price increases as the US Dollar value decreases.

Deflation or Inflation

Commodity prices in the coming years will be influenced by two the forces of deflation and inflation. If deflationary forces dominate, commodity prices will tend to decrease; if inflationary forces dominate, commodity prices will tend to increase. However, this is not always and necessarily the case.

There has been much discussion recently about whether the United States is heading for generally much higher inflation or a deflationary depression; in either case, commodity prices have a tendency to rise.

During the last twenty years or so as mentioned above, commodity prices have essentially been in a long bear market with declining inflation rates. This decline in inflation has even now gone to the point of a general fear of impending deflation. This is especially true when consideration of the massive export potential of China to produce manufactured goods at significantly lower cost than the Western industrialized countries. However, the loose monetary policies of the Western industrialized countries could lead to much greater and even severe levels of inflation in the near future. This in turn could raise commodity prices significantly likewise.

In the case of inflation, it is easier to understand; however in the case of deflation, it may appear to not make sense. But in the Great Depression, commodity prices doubled from a low in 1932 to a high in 1934. If the decline in the demand of commodities in a deflationary recession is met with a larger decline in the supply of commodities, commodity prices may then likely increase. This is essentially the case now in the global economy; last year, commodity prices increased by more than 20% in this regard.

The current situation is somewhat like the beginning of the stagflation of the 1970s – with inflation in some areas and deflation in other areas. In particular, it appears as if inflation is appearing now in areas involving resources and deflation is appearing in areas involving mostly Asian exports of low-cost manufactured goods, clothing, and household items. There is much discussion as to whether deflation may also extend to the real estate sector. Inflation in areas involving resources means rising commodity prices.

US Federal Reserve Board Policies

Some significant conditions for rising commodity prices are the loose monetary and fiscal policies of the US Federal Reserve Board.

Excessive monetary stimulus and rapid credit expansion will always eventually lead into hard asset markets such as real estate, commodities, and precious metals, which then, in turn, lead to higher inflation rates.

The Federal Reserve Board recently published an essay entitled “Preventing Deflation; Lessons from Japan’s Experience in the 1990s” (International Discussion Paper, Number 729, June 2002). In this essay, the Federal Reserve Board mentions “that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus – both monetary and fiscal – should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.” The effect of these loose monetary and fiscal policies have the overall effect of US Dollar depreciation, leading to the situation described above under the section entitled “US Dollar Depreciation”.

Furthermore, following a January 2002 meeting of the Federal Open Market Committee (FOMC), a Federal Reserve Board mentioned that in the extreme event that its loose monetary and fiscal policies become ineffective, it would take “unconventional measures” such as the “buying of US equities” or any “state or local debt, real estate and gold mines – any asset”.

And more recently, the next potential likely incumbent of the Federal Reserve Board Chairman after Alan Greenspan, Ben Bernanke, mentioned his now famous statement about the government having a technology called the printing press to which it can use in fighting deflation.

All of these Federal Reserve Board policies are setting an environment that will be very conducive for a depreciating US Dollar currency and ensuing rising commodity prices.

Rising Government Budget Deficits

Rising government budget deficits, at both the federal and state levels, will add significant pressure to a depreciating dollar, in turn providing another factor for rising commodity prices.

Energy Situation

A very positive factor for commodities is the energy situation. The current longer-term relatively higher energy prices, such as oil, are creating a situation similar to the energy crises of the 1970s.

There have been numerous recent studies which indicate that current oil and gas fields have peaked in their maximum levels of production, that the easy-to-get oil and gas reserves are being depleted, and that future potential reserves will be much more expensive to mine and extract. And not to mention the growing demands and usage of energy by the developing world - especially from such countries as China, Vietnam, and India.  Recently, China battled against (and lost) Japan to gain a oil pipe line from Russia.

All of these factors point towards much higher oil and gas prices, translating to much higher commodity prices in general. It is to be noted that many of the other commodities, such as soft agricultural commodities, are either derived from or produced with oil and gas products.

Recession or Recovery

Another point worth noting is that commodity prices will increase significantly in the periods immediately after the end of a recession; this is because after recessions, demand for commodities generally picks up considerably.

As the global economy expands, the demand for commodities will correspondingly rise and with it, commodity prices. An economic recovery will generally demand a higher usage of commodities, resulting in higher commodity prices.

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