Was it a bubble? That's the question on the minds of commodity investors everywhere. Does the recent pullback in commodity prices represent the bursting of a short-term bubble or a modest correction in a broader bull market?
Those questions have taken on all the more importance—and complexity—given the recent turmoil in the U.S. stock market. With the future returns on equities uncertain, commodities will be receiving more attention than ever from investors seeking noncorrelated returns.
Heather Bell, managing editor for Journal of Indexes, spoke with several experts on the global commodities markets about some of the key commodities-related issues on investors' minds.
Ashmead Pringle, president of GreenHaven Commodity Services, which is manager of the GreenHaven CCI Fund (AMEX: GCC)
Journal of Indexes (JOI): Have commodity prices peaked? If not, where are we in the commodities cycle?
Ashmead Pringle (Pringle): I don't think they have, for several reasons. First, I believe global crude oil production is peaking and may have already turned down. While demand in the developed countries is falling and will fall further as we substitute for petroleum energy, the growing demand from the developing world will more than offset this. Thus, for the next five years or more, we see global crude oil demand growing while supply will be shrinking. Higher petroleum energy prices are the only possible result. Second, global demand for food is outpacing supply. Water and arable land are becoming scarcer. Luckily, we have a big world wheat crop this year and no real supply issues in the grain markets. If we were to have one or two bad years in a row, you'd see a big price spike in the ag markets. Third, the U.S. has spent itself into a huge hole and is in a severe credit crisis, to boot. It's almost certain that the only way out is to keep pumping up the money supply, weakening the dollar and fueling inflation. That's bullish for commodities.
Where we are in the cycle is harder to say, but we're a long way yet from the old highs, adjusted for inflation. In real terms, commodity prices were at Depression levels in 1999–2000. Since then, they've obviously appreciated substantially, but they are still far from matching the highs set in the early '80s. That was true in July before commodities corrected sharply, and it's truer now.
JOI: Which areas of the commodities market do you believe will be most attractive over the next few years?
Pringle: Pretty much all of them, but I think the Ags will be the best-performing group, followed by Precious Metals and Energy.
JOI: Have index investors and other asset allocators been a significant factor driving the increase in commodities prices?
Pringle: No doubt. However, the impact on the market by any investor comes when they buy or sell, not when they hold a position. As money flowed into long commodity positions, it certainly pushed prices up. And if it flows out, it will push prices down.
JOI: How much of the average investor's portfolio should commodities represent?
Pringle: There really isn't a single answer for all, and you have to define commodity exposure. Is it exposure just to physicals or futures, or does it include equities that are in the commodity sector? If we don't count equities, I'd say 5 to 15 percent is a reasonable range. Below 5 percent, the average investor isn't going to see much of an impact from any asset class.
JOI: Are commodity-producing equities a good replacement for commodity futures exposure?
Pringle: The conclusion of the famous Yale study [by Gary Gorton and K. Geert Rouwenhorst] of commodity investment was that the related equities were not as effective as direct exposure. Equities as a class don't do well in periods of unexpected inflation, while commodities do, and the two classes behave differently during the phases of the business cycle. Plus, many equities are not pure plays.