Thursday, January 27, 2011

The Cure For High Prices Is High Prices

A quick, cursory glance at almost any commodity chart will lead the viewer to only one conclusion: watch out! Agricultural products, precious metals, industrial metals, rare earth minerals, energy, etc. have all experienced a steep ramp up over the past 6 months.

That increase in price has been explained by a weak dollar, upcoming inflation, emerging market growth, a rebounding economy, permitting difficulties, and the growth of commodity influenced ETFs. Given the foregoing, demand has been significant and prices have risen. Investors have taken notice, but so have producers.

Timing anything is notoriously difficult. This cycle will be no different than trying to figure out when tech stocks would peak or the last deadbeat would receive his triple subprime home equity loan. You can sense it's coming, but when?

My guess is that we're about 2 years away from the cure kicking in. The process has already begun as high prices has encouraged large numbers of new mining projects in various stages of permitting/buildout and we are beginning to see a significant number of untilled acres being planted. The cure for high prices is high prices.

To avoid the impact of increased supply, world economies need to get going and keep going. Any stutter along my 2 year guestimate and investor/speculator confidence could weaken, causing prices to start a readjustment process. ETF money isn't the same as industrial demand and if that segment of demand starts to move elsewhere, the new supply will look overwhelming!

Like the greater fool that I often am, I'm sticking with my allocation of commodity related companies and ETFs. The likes of Bunge, Cloud Peak, and Devon are likely to remain in my portfolio even after my 2 year threshold. But, the ETFs, GLD, SLV , and EWZ, are likely to be sold as months elapse and we get nearer to increased supply and weaker demand.

The recent sell off in many commodities will likely be reversed and owners will be rewarded by further moves upward, but sometime over the next couple of years, high prices will drum up supply and prices will correct. It always happens.

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