Thursday, March 20, 2008

Inflection Point for Commodities

There are several factors putting pressure on commodities: overbought technicals, short term strengthening dollar, popping of speculative micro-bubble, hedge funds needing to cover margin calls and thus selling anything with gains, weakening of the economy, and relative geopolitical stability. Deflation.

As outlined in the New York Times, these factors are leading to a drop in gold, silver and oil. And when commodities drop, it is often precipitous. The smart money gets in early and gets out early, and it's time to take profits if you have not already done so.

The booming commodities market has become increasingly attractive to investors, with hard assets like oil and gold perhaps offering a safe hedge against inflation, as well as the double-digit gains that have fast been disappearing from the markets for stocks, bonds and real estate.

Undeterred by the kind of volatile downdrafts that sent oil plunging 4.5 percent Wednesday, to settle at $104.48 a barrel, large funds and rich individual investors have sent a torrent of cash into this arcane market over the last year, toppling records for new money flowing in.

Small investors are plunging in, too, using dozens of new retail commodity funds to participate in markets that by one measure have jumped almost 20 percent in the last six months and doubled in six years.

But this market, despite its glitter, offers risks of its own, including some dangerous weaknesses that are impairing the ability of regulators to police fraud and protect investors. Commodities are also vulnerable to the same worries affecting the rest of Wall Street, where on Wednesday the Dow Jones industrial average plunged almost 300 points, erasing more than two-thirds of Tuesday’s steep gains.

Moreover, the biggest speculators and lenders in the commodities markets are some of the same giant hedge funds, commercial banks and brokerage houses that are caught in the stormy weather of the equity, housing and credit markets.

As in those markets, an evaporation of credit could force some large investors — especially hedge funds speculating with lots of borrowed money — to sell off their holdings, creating price swings that could affect a host of marketplace prices and wipe out small investors in just a few moments of trading.

My take is that the long term case for energy, grain and even gold may be valid, but the dollar should strengthen from its oversold position in the short and intermediate term. Positions that would capitalize on this would be Ultrashort Emerging Markets (EEV) or Ultrashort Oil (DUG).

Technology, especially semiconductors have been forming a nice bottom over the last few weeks, which is usually a sign of accumulation. Early, aggressive buyers could look at Sybase (SY) or Taiwan Semiconductor (TSM) or Applied Materials (AMAT). A more careful approach would be to wait for greater conviction, but tech may lead us out of the bear market. Taiwan ETF (EWT) has a lot of TSM and should be a solid player in the intermediate term.

One play may be to go long EWT and short emerging markets (EEV), and keep dollars on hand for now.

Disclaimer: I'm a simple working stiff who knows less than nothing about finance and economics. My interest in the market is solely for entertainment purposes. In no way should my ranting serve as investment advice in any way. (Unfortunately, the same disclaimer is true for every financial "adviser" I've ever sought out.)

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