Implications of the Commodities Bust

Last week I posted that commodities have unmistakably climaxed and cited as evidence the destructive technical action in the Commodities Research Bureau Futures (CRY0). It logically follows that we should assess the implications for this nascent reversal.

First, the obvious: if the US economy can grow above the long term 3.1% trend for the last several years in the face of higher input prices, imagine what it will be able to do with the relief that’s on the way.

Second, it’s time to sell short Hugo Chavez and the Mullahs in Iran. They’ve caused plenty of mischief the last several years, stoking anti-American fires all over the world. Significantly lower prices for their oil will slow these activities. In fact, the outlook for these rogues is probably far worse than most imagine. Government run commodity sectors have a long history of poor long term performance. In most cases the proceeds are not reinvested. The money is often wasted through corruption, redistribution to restive citizens in an attempt to quiet discontent, and the advancement of their revolutionary cause abroad. Meantime their easily accessible oil is being exhausted. The longer you pump a field the more difficult it becomes to extract what remains. In order to halt this production decline the sophisticated equipment and services that can only be provided by private Western companies are badly needed. But they will not be available as these companies have seen their holdings in these countries expropriated and contracts broken and having suffered such reversals will be unlikely to return under the current governments. It will be a bitter time for these regimes, and of course they will add this to their list of real and imagined grievances against us. But the increased sense of worldwide security that will ensue will benefit our markets, which have in part been held back by the seemingly unstable international situation of late.

Finally, I note an interesting divergence in a key index that I think is important. The NYSE International 100 about doubled off the bear market bottom to its top the middle of this year. But lately, with many important indices making higher highs, this index is taking out recent lows and looks technically weak. The reason isn’t hard to fathom. Like most indices this one is subject to the fashions of the day, and nothing’s been more fashionable than commodities, steel and energy. And 30% of this index is related to these sectors. Predictably, of the 11 new entrants to the index over the last two calendar years every one of them hails from these sectors. This, of course, speaks to the lack of sophistication of many overseas economies and the reason why foreigners rush to reinvest their money here, financing our mortgages at what are even now historically low rates. But more importantly it means that many overseas funds are likely to start underperforming. And investors everywhere, from John Q. IRA Rebalancer to those with deep pockets, are going to start to notice this divergence the next time they review the mutual fund quarterly performance charts. And they are going to yank money from these funds they couldn’t get enough of the last couple of years. This money is more likely than not going to be reinvested in funds that focus domestically. There is likely to be a steady and significant inflow over the next year and that means only one thing. Domestic fund managers will have increasing wads of cash to put to work in our markets.

The conclusion is clear. More now than at any time since March ’03 it’s time to buy American stocks. They’re cheap, and they’re getting ready for liftoff.