Commodities Bust Straight Ahead?

Seems Like Old Dot.com Times

Investors with an active memory are feeling as if they've seen something similar to what's happening to the commodity markets before.

In December of 1999, the Dot.com boom imploded, and the commodity boom was seeded, although it took two years for the big bull run in oil and other commodities to become apparent. The 9/11 attacks were the catalyst for a boom that led to a doubling of the CRB index, until it topped out in May of 2006.

Yet, since May 2006, the CRB index has lost neary 18% of its value, and the charts suggest that there is more to come.

Indeed, the current market action, barring a very dramatic reversal, suggests that the commodity boom may have ended.

Familiar Signs

It took several months for most investors to realize that the Dot.com boom was over. And that may be the case for the commodity boom as well, given current reactions.

Yet, there are clear signs that something important has happened to the seemingly never ending up trend for commodities.

First, two hedge funds have now essentially disappeared, as MotherRock imploded, and Amaranth has been bailed out by JP Morgan and Citadel, another hedge fund. Amaranth investors have been reported to be willing to sell their stakes in the fund for less than 50% of their current worth, which was depleted by 50% after recent trading mistakes.

Second, reports of potentially major hits to pension funds and other traditional non-commodity players are being rumored.

According to the Wall Street Journal: '"until 2003, there wasn't a whole heck of a lot of interest in commodities," says Neil Rue, principal at Pension Consulting Alliance Inc. in Los Angeles. "But commodities are becoming a major asset class and investments in the area have multiplied since 2003. It wasn't 10% or 5% a year, but much more than that." Mr. Rue cautioned pension-plan clients to be wary of commodities.'

This comes in the face of the number of commodity hedge funds rising over three fold in the last several years.

More important, other signs reminiscent of the Dot.com boom are quite evident.

According to the Journal: "Much as they did with tech-oriented investments shortly before they tanked in 2000, individual investors also have rushed into commodities, via stocks of commodity-related companies and mutual funds that specialize in such investments. There are 48 mutual funds that invest in commodities and related shares managing $56 billion, up from 34 funds with less than $10 billion three years ago, according to fund tracker Morningstar Inc. The Commodity Real Return fund of Allianz AG's Pacific Investment Management Co. has grown to more than $12.2 billion, from $8 billion about a year ago."

And then there are the exchange traded funds: "The 13th-largest holder of gold in the world isn't a central bank but an exchange-traded fund, a type of security that trades like a stock and tracks the price of an underlying investment class. StreetracksGold Trust, the largest gold ETF, has assets of $7.5 billion, up from $2.7 billion a year ago, mostly from new investments."

Heading For The Exits

As with any momentum market, the rise is exhilarating, but the fall, unless you are a short seller, is potentially devastating.

Yet, according to the Journal, there are signs that we are at some stage of just such a situation, as "Now there are signs that some of that "hot" money is exiting the market."

Commodity funds have been speculating on just about everything, even in obscure markets such as lead: "Lead illustrates the impact: It's basically industrial waste, the unloved byproduct of processing copper and gold. But prices for lead -- mostly used in batteries, primarily for vehicles -- have more than doubled in the past five years, even though stockpiles are high."

The Journal added: '"Large speculators began to liquidate gold and silver," wrote Mary Ann Bartels, a Merrill Lynch analyst, in a report this week. "But there are no signs of panic that accompany a bottom."'

There are also other signs that caution, although not panic, is on the rise.

1. "The gold ETF has seen little new money in the past month. "

2. "Merrill Lynch's research suggests that hedge funds that speculate in oil have been doing some selling lately, but many actually added to their natural-gas positions while keeping their heating-oil positions unchanged. "

3. "The Pimco commodity fund is seeing little new investments lately, in part because it's down almost 7% this year, though it also hasn't seen much in the way of withdrawals."

Conclusion

We may be seeing the early phases of the end of the commodity bull market, although this is by no means certain.

One thing is nearly certain, though, the flow of money into commodities is at the very least slowing.

Price action in stocks, especially technology suggests that money, presumably coming from commodities, is coming back to traditional momentum sectors.

If this is the end of the commodity bull market, and current apparent trends remain intact, barring external events, stock investors could be in for a long ride toward higher prices.