Commodities: Don’t Be Fooled by a ‘Syria Rally’

Commodities: Don’t Be Fooled by a ‘Syria Rally’


As geopolitical tensions have heated up, so have the commodities markets. The prospect of a widening Syrian conflict temporarily sent crude oil futures above $110 a barrel for the first time since May 2011 and has played a role in the latest stages of the gold market’s push back into bullish territory. (The renewed interest in gold has also been driven by the prospect of the Fed beginning to pull back on the monetary policy that has kept interest rates so low for so long.) The precious metal has conducted a stealth rally since hitting lows in June and now is up more than 20 percent from its June low of $1,180.20 and is trading (in the spot market) above $1,400 an ounce in recent days.

Oil and gold aren’t the only commodities rising along with the recent heat – though in other cases, the connection is much more literal. A spate of hot, dry weather has created new uncertainty about the health of both the corn and soybean crops, reinforced by Monday’s weekly crop conditions report from the U.S. Department of Agriculture that rated only 58 percent of the soybean crop as good to excellent, down from 62 percent the previous week. Unsurprisingly, soybeans hit a one-month high, followed by corn, even though the latter is closer to harvest and at a less critical stage in its development.

In the base metals markets, some pressures that weighed on prices seem to have abated as improving signs from China (better manufacturing data, some new infrastructure products) generate optimism about demand.

Even sugar prices are at five-month highs, although that has more to do with intervention on the part of the Department of Agriculture, which has been buying sugar from processors and funneling it to ethanol manufacturers in an effort to forestall processors from defaulting on federal loans coming due over the course of the next month. Clearly, the rally in the sugar market has been, if you’ll forgive the phrase, artificially sweetened. The rally is taking place not based on any long-term upbeat outlook but in response to short-term factors that aren’t likely to be sustainable.

The question is to what extent the same can be said of the rest of the commodities market: Is it even remotely possible that we’re in for another secular leg up in the bull market for the asset class or have the recent gains simply been a fluke?

Sadly for commodities bulls, the latter is more likely to be the case. The recent years-long runup in commodities prices was born in the wake of the 2001/2002 economic slump and subsequent recession. It was rooted in a global economic rebound and particularly in the almost hectic pace of growth in China. Base metals prices spiked so high that in some parts of the world, commodities bandits stole manhole covers, memorial plaques, lead from church roofs, and copper wire from railway signal stations. As Paul Christopher, chief international strategist at Wells Fargo Advisors, warned clients in a recent note, today’s environment is radically different and “commodity prices lack the fundamental support for a sustained rally.”

That doesn’t mean that there aren’t some profits to be made here in the short term. Uncertainty of any kind will be a boon for the gold market, and there’s plenty of that right now. Historically, fears of a regional conflict in the Middle East raise concerns about a supply shortage of crude oil like that witnessed during the 1970s, so the civil strife in Egypt and the Syrian civil war may help put a floor under energy prices. And at least until this year’s crops are safely harvested, weather and crop condition news will generate volatility in soybeans and corn and possibly fuel some additional gains.

Don’t mistake these short-term trends for anything more significant, though. This week’s upward revision to U.S. GDP growth in the second quarter (which boosted the pace of expansion to 2.5 percent, well above the economists’ consensus forecast of 2.2 percent) may offer a more upbeat picture of the U.S. economy, but growth is far from dramatic. (And it’s hard to tell just how the economy will react to rising interest rates.) Chinese growth is weak, at least relative to what it has been in recent years, and that means that the single largest source of demand for all these commodities isn’t likely to experience a massive revival. Infrastructure projects are likely to continue, but not at the kind of pace witnessed over the last decade. So while the prices of base metals may stabilize, scarcity isn’t likely to propel them sharply higher for prolonged periods of time.

In short, the elements needed to say that recent price movements represent the beginning of a secular or even cyclical bull market in commodities simply aren’t there.

What does that mean for your portfolio? First of all, it means being very careful when it comes to the stocks of commodity producers. Many of those producers expanded capacity only to have new production come onstream just as prices were falling. A good number of aluminum, copper and energy producers have shut in that excess capacity, but a rise in prices may bring new supplies on stream, with predictable results.

Secondly, if you do decide to take a short-term position in commodities via an exchange-traded fund of some kind, the best bet may be to pick one that offers broad exposure to a range of commodities. It’s too hard to predict which sector – metals, agricultural products, gold, the energy complex – will see big gains and which might turn turtle in the coming weeks. There is a reason that the idea of hedging one’s bets originated in the commodity markets, and that’s precisely what you’ll want to do before you dip a toe in these waters right now.