Friday, October 9, 2009
One of the ultimate truths is that liquidity eventually flows into undervalued assets. This is the reason the commodity bull market began in the first place.
In `99 and 2000 paper assets reached ridiculously extreme overvaluation compared to commodities. At that point a great secular change took place. Liquidity started to leak out of stocks and other paper assets and into severely depressed commodities.
That leak rarely ever unfolds in an even distribution between all commodities. Some outperform during the first phase and some under perform based on the current fundamentals at the time.
During this particular commodity bull the first phase was led by energy and base metals. The fundamentals were supporting these sectors as growth in emerging markets and generally strong economic growth world wide put heavy demand on energy markets that because of the preceding 20 year bear market were just not prepared to meet this increased demand.
Naturally prices rose.
Now we have completely different fundamentals driving the second phase of this commodity bull. Unfortunately oil is price sensitive. By that I mean that high prices lead to demand destruction. They also lead to economic destruction which only intensifies demand destruction.
I've noted many times in the past that every time oil has spiked 100% or more in less than a year it has led to a recession. That move to $147 last year was no exception.
This year we've already seen oil spike from $35 to over $70. I suspect this is already eating away at any economic recovery especially since we really haven't recovered.
Countries with high unemployment and depressed economic activity are really in no position to handle surging energy prices.
High oil prices are oils own worst enemy. I suspect oil is going to be on a rollercoaster for many years as its constantly cycled up and down by the forces of easy money and demand destruction.
Gold on the other hand is the perfect commodity to benefit from the current fundamentals. Gold and especially silver are not price sensitive. High prices do not cause demand destruction (well to some extent it does in the jewelry market). The reason is that these two metals have a monetary component. Through out most of history gold and silver have been considered money.
Who in their right mind is going to complain if their money increases in value? That just means they have more purchasing power. That's not a reason to sell, that's a reason to buy.
This stage of the commodity bull is going to be led by precious metals and probably later by agriculture (maybe a third phase).
I expect the gold:oil ratio to remain above the 14ish level for this phase of the commodity bull.