Joe Kennedy once famously said that he knew it was time to exit the stock market when his shoeshine boy offered him a stock tip. That principle, that when financial news and opinions become mainstream, the move is over, can also be applied in reverse. The collapse in commodity prices and in the stock of companies in the associated industries is nothing new. It started when oil began its dramatic fall over a year ago and has continued ever since, fueled by fears about slowing global growth and a relatively high dollar. In the last couple of weeks, however, it seems to have passed into the mainstream. It seems that every news bulletin and publication has a story about the death of commodities right now, which, to a contrarian with an understanding of history, suggest that now is a good time to be buying.
Anecdotal evidence has, by its very nature, limited use, but I will pass on a story nonetheless. At a dinner part this past weekend a friend who is in the manufacturing business collared me to talk about commodities. He told me that he didn’t really follow markets but had heard that oil, metals and grains among others were in freefall and that he had just gone through his portfolio and sold everything associated with them. It struck me as the shoeshine indicator in reverse. I gently pointed out that oil, for example, had already lost around two thirds of its value as compared to the high last year, and had in fact already bounced off of a low.
It is a sad fact that retail investors are usually the last to buy into a bubble and the last to sell at the bottom of a dip, and there is a perfectly logical reason for that. They usually don't even hear about these moves until the extreme position is reached, at which point the story crosses over into mainstream media. Betting on that being the case here is, of course, extremely cynical, but there is a good chance it could be extremely profitable.
I will freely admit that for those of us looking for a bottom in the commodity space there have been a few false starts already, and that this could be another one. There could be further to fall I guess, but from a long term perspective it is hard to imagine this slump lasting for years. The world’s largest central banks, the Fed, the ECB, the PBOC and the BOJ, are all pursuing easy monetary policy even as the jobs market, at least in the U.S. and Europe, is showing signs of strength. That suggests that at some point inflation rather than deflation will be the concern, and commodity prices will recover.
In addition to the attempts to stimulate demand the supply side of the equation will, if basic economic theory holds true, begin to self-correct. The high prices of commodities that stimulated production are now a thing of the past and, just as they led to an exaggerated response and over supply, so the resultant correction is likely to lead to under supply in the not too distant future.
Lastly, and perhaps most tellingly, now that stories about the commodity collapse are everywhere the market is indicating that we may have found a bottom. Oil, gold and several other benchmark commodities are trading above the lows reached at the end of last month, as you can see from a six month chart for the PowerShares DB Commodity Index Tracking Fund (DBC).
As I said, there could still be another leg down to come, so this is not the time to go all in on commodities. Judging by the level of coverage, however, and the fact that even those who normally don’t pay attention are convinced that a full on collapse is happening, it may be a good time to start dollar cost averaging into the space.