Is speculation a big factor in commodity prices? The answer is clearly yes. While economic factors, such as the increase in demand from emerging countries helped launch the dramatic advance in raw material prices, much of the action this spring has been due to speculation. Let’s consider what that means. Typically, the term “speculator” is applied to those using leverage in search of a quick profit. As a result, speculative action is often dominated not by economic fundamentals but by monetary conditions. There is no doubt that people and entities who fit this description (such as hedge funds) have built sizeable positions in commodities, which makes the sector vulnerable. The relevant questions are these. Will speculators aggressively shift to other sectors because opportunities there are better, and will a change in monetary conditions force them to cut back on leverage? For now, both possibilities seem benign, but it’s worth keeping an eye on them.
The stocks of many natural resource producers are still reasonably priced. Even though commodity prices have had sharp run-ups driven by a strong speculative element, analysts have generally been cautious: their earnings assumptions are typically based on historical norms and use raw material prices considerably below current ones. As a result, some high quality energy and mining companies are still trading at multiples below those of the mature, low-growth firms that make up the S&P500. Another encouraging fact: commodity producers make up roughly 12% of the S&P500, about half of the content they reached when the sector reached its last high cyclical high.
Many readers want to know what today’s “hard currencies” are. Those of you who remember the Seventies know that the Swiss Franc, the German Mark and the Japanese Yen were viewed with the type of respect usually reserved for gold. They were the currencies of nations that managed to balance their budget, generate significant current account surpluses and keep inflation low—at a time when the US experienced the opposite trends. In the early Eighties, as America’s problems receded and the dollar regained credibility, the term “hard currency” gradually disappeared from the vocabulary of investors. Today we are once again confronted with the possibility of a serious US dollar decline, but few currencies look attractive. The Japanese Yen is very undervalued from a trade perspective, but Japan’s fiscal position remains difficult. And the Euro is the currency of an economic block that’s challenged by a horrible constellation of demographic, fiscal and economic woes. Switzerland has pursued a sounder monetary policy than most but, alas, its fate is intricately tied to that of the EU with whom it conducts an overwhelming portion of its trade. What about the commodity currencies? Australia and New Zealand are major beneficiaries of the raw material boom, but they both have substantial current account deficits. What’s left are the Canadian dollar and gold, which I would single out as the two key alternatives to an increasingly vulnerable US dollar. Canada is the only G7 nation that generates a sizeable current account and budget surplus, has inflation under good control and hugely profits from the global rise in commodity consumption. And then of course there is gold, the world’s only currency asset that is not a government’s liability. Those of you who read Perspectives regularly know that I expect the Canadian dollar to reach above par before long. As to gold, I believe it will climb considerably higher than its recent $720 peak.
Peter Cavelti’s background as a financial analyst and author spans 35 years and four continents. His grasp of global issues is extraordinary and his comments and books have been published internationally. He was president of Canada’s Guardian Trust and subsequently owned his own firm, which managed some of the best-performing natural resource mutual funds. Peter firmly believes that only an integrated understanding of geopolitical, demographic and economic events can lead to successful investing, and that is what his web service Perspectives is about. If you feel keeping on top of relevant global events takes too much time, Perspectives is for you. Whether it’s investment advice or political analysis, Peter offers his insights in concise and easy-to-read form. Best of all, Perspectives is free. Visit www.cavelti.com and sign up today!