Will commodities boom last

As oil and gold prices hit record highs, and grains stay up, speculators rush in.

from the March 7, 2008 edition

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A central reason: the growth of developing nations. From China to Africa, they are using more commodities, and in many cases they also benefit when the price of those materials goes up.

The trend also draws strength from concerns about a resurgence in inflation. "This is often the environment when investors turn to commodities," says Paul Kasriel, an economist at the Northern Trust Co. in Chicago. "I'm not that surprised about gold."

Gold is typically viewed as a haven of stability when inflation is eroding the purchasing power of paper currencies such as the dollar.

Some analysts say it is no coincidence that a surge in commodities began in earnest around the same time the Federal Reserve began cutting short-term interest rates last fall. That monetary easing has continued this year, with Fed officials signaling that further rate cuts are likely in a bid to stabilize the housing and credit markets.

"I'm still quite bullish" on gold, says Dennis Gartman, a commodity analyst who publishes the Gartman Letter in Suffolk, Va. But if the commodity rally may run for a good while, some of the money flows simply represent investors who hope to buy high and sell higher.

"The folks in the grain business are very upset about the fact that so much speculative cash is flooding into the grain market," Mr. Gartman says.

Commodity cycles historically can last a decade or more, so the current bull run could have staying power even though oil and gold have been rising for several years now.

Buoying demand, also, is a long-term shift among investors looking for the best way to diversify their portfolios.

Increasingly, "alternative" asset classes such as commodities are seen to play a vital role even for everyday investors. The idea is that during bad times for stocks and bonds, these alternatives provide a beneficial offset.

Commodities are an excellent diversifier, says Craig Israelsen, a Brigham Young University finance expert.

Commodities have traditionally been the province of arcane futures and options contracts. But now investors can easily buy in using mutual funds and exchange-traded funds. Large investors such as pension funds have popularized the concept. The question is whether the benefits of commodity investing will persist when so many are following that strategy.

Another wild card is whether the demand for commodities from emerging markets will continue in the face of a slowdown in key export markets – the US and Europe.

"I don't buy that," says Mr. Kasriel.

But some forecasters say commodities will remain strong. High oil prices, for example, may reflect a long-term outlook for tighter supplies. Rex Tillerson, who heads Exxon Mobil, said in a CNBC interview this week that speculation may be adding $10 to $20 per barrel of oil.

Rising prices for wholesale materials don't have to mean that consumer inflation goes up. Still, worry has grown that US inflation could rise beyond its recent annual rate of about 4 percent. David Ranson, an economist at H.C. Wainwright & Co. in Beverly, Mass., predicts a good next five years for oil, but that the stock market will do better still.

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