Are the commodities markets changing track?

Yesterday, gold prices hit a 10-day high at $839 an ounce, crude oil prices soared overnight in their biggest rally for three months to settle at over $120 a barrel and the dollar saw its biggest monthly loss against the euro since mid-July.

These price movements will not come as surprise to Contrarian Profits regulars. Last Thursday, The Sovereign Society’s Eric Roseman urged investors not to abandon gold because he didn’t believe the dollar rally would last. The same day, gold bug Ed Bugos advised readers to load up on cheap gold in anticipation of a rally in prices.

Although a definite trend reversal in gold and oil has not yet emerged, yesterday’s gains could signal further upswing ahead.

Smart Commodities UK editor Garry White says there has been no change in the long-term fundamentals of either asset class…

This is no bursting bubble.

The fall has been caused by a number of factors coming together. We shall consider them one by one.

Firstly, there’s the euro.

The eurozone economy has disappointed. Reality has finally hit home for investors who reckoned that the euro was a safe port in the economic storm.

The truth is that they were wrong. The situation was much worse than most had expected.

This has caused a rally in the dollar over the past four weeks.

This was confirmed by recent GDP data. One week ago it was revealed that eurozone output had fallen by 0.2% in the April-June period. The euro economy had actually contracted for the first time since the single currency was launched in 1999.

Yet despite problems in the continental European and UK markets, I expect the dollar’s recent upward trend will be reversed sometime soon.

The dollar’s comeback will be short lived

The reason that the dollar has strengthened is nothing to do with the strength of the US economy. The country is still in exactly the same mess it was in a couple of months ago.

Freddie Mac (NYSE:FRE) and Fannie Mae (NYSE:FNM) are likely to be bailed out by the US taxpayer. The full implications of the credit bubble have not been played out. The Average American is still swimming in debt… and this debt is getting worse by the day.

In 2005, the US personal savings rate actually went negative. This means that, in total, Americans are borrowing more money than they save.

Then there’s healthcare.

The rise in healthcare costs is also exceeding income growth, which means that fewer people have taken out adequate insurance. This is expected to lead to an increase in medical debt for the average American.

Petrol gas and food prices are also on the up — at the same time as home values are declining. To add to the squeeze on the average family, wage increases have also been capped.

The US economy is still a mess. The respite for the dollar really is a temporary phenomenon.

America can’t stop cutting oil consumption forever

Another factor driving the oil price has been consumption.

Much has been made of falling consumption in the US… but can this continue?

I expect not. This is down to something called the elasticity of demand.

The US has been cutting down on its oil consumption. Logically, individuals and businesses will cut out the most discretionary consumption first. In other words they cut out the least necessary journey’s first.

This has been seen in falling gasoline consumption. As of 15 August, the four-week moving average showed a gasoline demand decline of 4.8% compared with last year.

The remaining consumption is therefore the most valuable to the individual, business or economy. This will be in terms of its contribution to GDP or its hit on a person’s quality of life.

This means that the remaining demand in the economy is much more inelastic. Total consumption cannot carry on shrinking at this rate. There are some journeys that people have to make.

This also leaves the US more exposed to supply disruptions, as its “buffer” has been removed.

I also expect that falling demand in OECD countries will be countered by rising non-OECD demand.

The next issue to consider is supply.

I don’t know if I have missed it, but no massive and easily accessible supplies of gold or oil have been found the past couple of months. This side of the equation remains very tight.

I also expect any new discoveries of oil will be expensive oil. Take the recent news from Iceland, as an example.

Iceland has invited tenders to drill in its offshore territories in the Arctic Circle. Submissions from interested companies are required by January.

Any oil found offshore Iceland will be between 800 metres and 2,000 metres below the surface.

Extracting this oil will be very expensive indeed. Working at the bottom of the ocean in subzero temperatures is no mean feat. This oil will never, ever be cheap.

New gold supplies will also cost more

Finding new gold reserves is also an expensive business.

As anyone who has followed mining juniors will know, funding is a key issue. With the credit markets seized up, mining companies are finding it really hard to raise money for exploration.

This will hit the supply side of the equation well into the future.

Some investors have fled to banks… but how long before they come back?

Another reason for the fall in oil has been sector switching.

Over the last couple of months, many professional and private investors alike have moved their cash away from what they saw as a toppy commodity sector and into bombed out banks.

Money moves where it multiplies best. Good judgment does not always go along with it.

With banking stock trading at a fraction of their traditional valuations, bottom seekers have moved into a sector they saw as a bargain. They have taken cash from commodities to pay for it — adding to the downward momentum in the sector.

But I do not expect this sector switching to continue. I expect it to reverse.

Last week, Merrill Lynch (NYSE:MER) said banks across Europe could be forced to raise an additional $70bn-$120bn in new equity. This is on top of the $120bn already raised.

Former IMF expert Kenneth Rogoff also reckons the failure of one of the big US banks is only months away. If I had any big money in the banking sector now, I’d be taking it off the table.

Political tension never far away

The next factors we have to consider are geopolitical tensions…

The Iran question looms large. Will the Americans or the Israelis bomb it?

I remain utterly convinced that war planes will be dispatched at some point in the not too distant future. It’s just a question of when… my money is on December.

This would send the oil price soaring as supply is cut. It would also send the gold price higher as investors seek a safe haven.
We also have Russia.

The South Ossetia “conflict” is nothing more than a minor skirmish. In my mind it is really an irrelevance.

However, hawkish sabre rattlers on both sides of the Atlantic have made the most of the situation. This has also raised the prospect of an oil and gas supply shock.

Nigeria is another issue.

The Movement for the Emancipation of the Niger Delta (MEND) continues to attack pipelines and disrupt supply. There is no end in sight and the situation is utterly unpredictable.

The global downturn won’t last forever

Finally, there really is light at the end of the tunnel. The global economy will pick up… eventually. Asian growth will save the day.

Investors are being fairly myopic at the moment. This always happens in a crisis. I can’t blame them. They are scared for their future.

But the truth is that the global economy will eventually emerge from it current gloom. It might take some time for it to happen, but happen it will.

Consumption of oil will be once again on the up.

So, I remain unconcerned about the oil and gold price correction — because that’s all I believe it is. I think that there is only one way for both prices to trend… and that’s up. Although, as we are seeing, it will be a bumpy ride.

P.S. Read on here to discover more about Garry’s newsletter, Smart Commodities.

Source: Here’s Why You Need to Be Ready for Oil and Gold to Rise Again