Monday, March 31, 2008

Barron's pans commodity investing

The cover story of this week's Barron's was Guess who's behind commodities boom ($), with this quote on the cover: "More than half of all bullish bets on commodities have been made by speculators, both big and small. When these markets fall, they'll fall hard, perhaps by 30%."

That quote summarizes the article pretty well. The cornerstone of the author's argument was the current record net long position of speculators and the corresponding record net short position of the commercials who are considered the "smart money". Commitment of traders (COT) data is indeed a valuable tool in analyzing markets, but to ascribe the price run-up to speculative demand alone glosses over the very real bullish supply/demand fundamentals. For example, the chart below (source: FABRI world agricultural briefing book 2008) shows that the record run-up in wheat prices was accompanied by an equally significant decline in its stock-to-use ratio. Similarly bullish supply/demand picture for other agricultural commodities can be found in the same source. [These charts also predict future price declines for several major crops. Obviously, the level of confidence to be placed on future predictions vs. past data is quite different. At any rate, the point is that speculative demand cannot alone explain the price increase in many agricultural commodities.]

If the main thesis of the Barron's article was that the commodities will correct further, I would have titled this post "Barron's pans commodities". Hell, I probably would not have written this post since I see some short term technical difficulties myself. However, rather than voicing an opinion on the future price trajectory, the article was really an indictment on investing in commodities, or to be exact, investing in commodities in long-only index funds. One particular quote belies the author's disdain

In other words, they [the commodity index funds] trade the naive and potentially fatal assumption that commodities have the same tendency as stocks to rise over the long run.

Much of the article was an accusation that the commodity index funds distort the futures markets and it even implied that the CTFC might rescind an exemption that allows these commodity index funds to take on large long positions.

Given the size of the futures contracts, the commodity index funds represent the only realistic chance that individual investors can participate in this booming market. I don't know about you, but the prospect of government limiting access to tangible things of real value all the while debasing the currency so that the prices of real things have nowhere to go but up does not sit well with me.

The article spoke of an upcoming CFTC meeting on Arpil 22 "to hear firsthand from participants to ensure that the exchanges are functioning properly". I believe concerned individual investors should let relevant government officials know where they stand regarding their freedom to put their dollars. The contact information below may come handy.

US Commodity Futures Trading Commission
Three Lafayette Centre, 1155 21st Street, NW Washington, DC 20581, 202-418-5000
Acting Chairman: Walter Lukken, (tel) 202-418-5014, (fax) 202-418-5550

US Senate Committee on Finance
219 Dirksen Senate Office Building, Washington, DC 20510-6200, (202) 224-4515
Committee Members

House Committee on Financial Services
House Financial Services Committee, Democratic Staff, 2129 Rayburn House Office Building, (202) 225–4247
Committee Chairman: Barney Frank