Daniel Harrison From Hard Assets Investor Reports: In the past year, currencies everywhere have taken on an inverse relationship to equity prices, relative to what they were doing earlier in the decade. For example, as the dollar has weakened, equity prices have rallied off the floor. In Asia, the yen—traditionally a bearish indicator—is soaring, while markets in Hong Kong, China and other Asian frontier countries have zoomed ahead to record gains.
Some money managers are now forecasting that another relationship is about to get plunked on its head, this time between commodities and equities.
For the most part in 2009, commodities have risen along with everything else, as high commodity-consuming emerging markets have led the way out of a deep recession in the U.S. and Europe. Gold is hitting new highs above $1,000 an ounce, and oil is back in the high end of its 2009 range, around $70 a barrel.
The story for equities is similar. After falling for a bit in late August and early October, the S&P 500 Index is showing gains of 17 percent year-to-date, fueled by massive liquidity provided by central banks earlier in the year.
But with economic uncertainty running high, there are signs that investors are beginning to shy away from U.S. equities in favor of emerging market ones and commodities. Depending on how third-quarter earnings pan out, that process could lead to a massive decoupling between equities and commodities.
Paul Mendelsohn, chief investment strategist at Windham Financial in Virginia, has been taking money out of many of his more profitable trades recently and allocating money toward commodities for this reason.
“I’m focused almost totally on commodities—that’s all I’m interested in now,” Mendelsohn told HardAssetsInvestor.com. “We’ve been increasing commodity exposure across the board, particularly in precious metals.”
“At some point the market has to decouple from the dollar and say that a decline in the dollar is not good for U.S. stocks. Then there will be a decoupling of commodities and equities,” added Mendelsohn.
Among Mendelsohn’s largest ETF holdings right now are the SPDR Gold Trust (NYSEArca: GLD) (GLD) and the Market Vectors Gold Miners Index (NYSEArca: GDX)(GDX), while his specific company holdings include Chesapeake Energy (NYSE: CHK)(CHK), Monsanto Company (NYSE: MON) (MON) and steelmaker Nucor (NYSE: NUE)(NUE).
Mendelsohn is not alone in his views. A survey conducted last month by researcher BetaPro found that 60 percent of financial advisers were bullish on natural gas and gold going into the fourth quarter, while 68 percent were bullish on crude and silver. The 300 advisers running more than $20 billion who were surveyed added that while they still favored emerging market equities, U.S. stocks no longer looked attractive.
The case for commodities investing is compounded by the fact that, despite a rally in raw materials and U.S. securities, the latter has outperformed the former this year, even as underlying demand from the BRIC block has grown. That indicates that there is still lots of value among many commodities for the companies that produce them, according to analysts.
For example, major oil producer Exxon Mobil is still 13 percent lower year-to-date, and the iShares S&P GSCI Commodity-Indexed ETF (NYSEArca: GSG) (CSG) is only 3.5 percent above its 2009 starting point. The United States Oil Fund (NYSEArca: USO) (USO) is not performing much better.
The thinking is that as money flows out of this year’s brightest performers in the financial, retail and technology sectors, many commodity-based companies and ETFs will begin to suck up a lot of the excess liquidity.
However, not everyone is convinced of an imminent commodities boom in the face of equity price declines. Justin Urquhart Stewart, a director at the U.K.’s largest boutique finance house, Seven Investment Management, points to a much-weakened export market for emerging countries.
“The demand [emerging markets] had before for equities was for themselves, but it was also to service an export market. That market will come back, but at a much lower level than it previously was,” Urquhart Stewart told HardAssetsInvestor.com. “Commodity prices cannot keep rising if the global economy keeps growing at a tepid rate.”
Some of that uncertainty appears to be showing up on the screens of quant-based commodity strategies—although there does appear to be more aggressive buying in play. The ELEMENTS S&P CTI exchange-traded note (NYSEArca: LSC)(LSC), a long/short commodity quant exchange-traded product, has been consistently switching its short positions in various commodity classes to long ones.
While the ETN’s investment focus was mostly bearish back in August, it is now only around 30 percent short. At the end of last month, LSC went long precious and industrial metals, leaving it with short positions only in agricultural commodities.
Regardless of how long it might hold up, many agree that a decoupling between equity and commodity performance has not looked so likely for more than a decade. That’s because the effect of the Federal Reserve’s massive liquidity supply this year is bound to fuel another asset class bubble, just as it did in the aftermath of the dot-com crash in asset-backed securities.
“The pump priming is fueling a new bubble in commodities. Emerging economies are not in as bad shape as we are; even European developed countries don’t have the problem we do to the same degree,” said Mendelsohn. “There’s a major shift taking place.”
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