Is The Federal Reserve Blowing a Commodities Bubble?

by Tony D'Altorio

Is The Federal Reserve Blowing a Commodities Bubble?

by Tony D'Altorio, Investment U Research

Tuesday, October 26, 2010

So here's the big question... Is the Federal Reserve blowing a commodities bubble?

Some analysts certainly think so. They can't come up with a better reason why prices have shot up so high.

And they have a point, to some degree.

The U.S. dollar certainly has tumbled on talk of QE2, another round of quantitative easing. Simply put, the Fed wants to print more money.

In response, the dollar has fallen nearly 5% against other major currencies since September 21... when the Fed started pushing QE2 in the first place.

That has sent the prices of many dollar-denominated commodities shooting up.

Thoughts of QE2 are also pushing down long-term interest rates. Many speculators like that effect enough to invest large amounts in commodities and stocks.

And the prospect of all that money flooding the financial system has people worrying about inflation. Hence the reason why gold continues upwards as well.

So yes, there is something to be said for the bubble argument. But contrary to that line of thinking, QE2 isn't the only factor driving commodities...

Three Reasons Commodity Markets Are Not in a Bubble

Physical commodities traders outright reject the notion of a speculative bubble. And they arguably have the most detailed intelligence on commodity market flows.

Instead, they - and others - believe we're in a super-cycle. And they have some solid arguments themselves...

1. Investors have little to no access to some of the commodities that have risen the most. Thermal coal, for example, has no futures market, yet is at a two-year high.

The price of barley has almost doubled since the start of the year. And tin, though not tracked by major investable indexes, has reached an all-time high in the past month.

The CRB index of basic raw material, which includes scrap steel, burlap and lard, recently hit a new record. But the S&P GSCI index, the most widely tracked commodity index, has to rise another 60% to beat its 2008 highs, thanks mainly to oil.

2. If QE2 really was sending commodities into a bubble, they all should be affected. Investors would buy them up indiscriminately.

Yet one of the most widely traded of the lot - natural gas - has fallen 40% this year and remains weak. Even oil, which has rallied a bit in the past two months, can't escape the $70-$85 a barrel range, where it has stayed much of the year.

Also, institutional commodities investors seem to be buying up commodities more as part of a long-term asset allocation strategy instead of a short-term move. Kamal Naqui, head of commodity investor sales at Credit Suisse, said, "I've seen a lot of clients recently; not a single one saw QE as the key bull argument."

3. The tightness in many commodities markets is due to physical supply constraints.

Russia's record drought has devastated wheat production. Heavy rains in Indonesia have hurt tin output, and previously underinvested copper mines can't keep up with demand.

The list goes on, telling a tale of too much demand and not enough supply each time.

Follow the Commodities Investments

Now, people who can't stop focusing on QE2 do have one valid point. Diego Hernandez, CEO of Codelco, the world's largest copper miner sums it up: "The dollar is not the same dollar that we used to have. It's a new world."

But even if the Fed doesn't print more money, commodities would still be moving higher. Fast-growing demand from emerging markets and decreased supplies ensure that.

And stocks, futures, mutual funds, ETFs and ETNs all exist to capitalize on just that. But here are two of the broadest-based commodity plays:

BHP Billiton ADR (NYSE: BHP) is the world's largest diversified natural resources company. It deals in a wide range of commodities, from iron ore to coal, copper, zinc, nickel, lead, aluminum, manganese, diamonds, silver, uranium and oil.

And it hopes to soon have a hold on potash, as well.

Elements Rogers Commodity Index Total Return (NYSE: RJI) also profits from a wide range of commodities. The ETN is based on an index by famed investor Jim Rogers.

RJI follows heavily traded commodities such as oil, gold and corn. But it also contains lesser-known goods like tin, rubber, lumber, rice, canola, orange juice, wool and azuki beans.

In short, an investment into commodities should prove profitable, QE2 or no QE2.

Good investing,

Tony D'Altorio

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