Commodities: Behind the Global Boom

The falling value of the dollar combined with tight supplies has fueled a big runup in commodities markets

Oil, wheat, gold, coffee—it seems everywhere a commodity investor turns, prices are soaring. On Sept. 19 and 20, oil hit an all-time record of $84 a barrel and gold jumped to $747, the highest since January, 1980. Barclays' iShares Standard & Poor's Goldman Sachs Commodity Index exchange-traded fund (GSG) has gained 14% over the past month, almost triple the stock market's gain.

Analysts say the falling value of the U.S. dollar combined with tight supplies across many commodity markets has fueled the big runup. And while there's a hint of speculative froth in some cases, most commodities appear to have further room to run.

"If the dollar is falling, commodity prices have to go up just to keep relative value the same," says Robert Baker, co-manager of the Oppenheimer Commodity Strategic Total Return fund.

Weather and Other Challenges

Across a wide swath of commodity markets, supplies haven't kept up with increasing demand. "Supply shortages are biting right across the commodity sector," analysts at Barclays Capital (BCS) noted in a Sept. 20 report. Looking ahead, inventories could get even slimmer, prompting the firm to increase its price forecasts across the whole array of commodities. Oil next year should average $77, copper could trade for close to $8,000/ton, and gold will stick close to $700, the firm forecasts.

Among the supply challenges: Wheat production has taken a hit from multiyear droughts in key producing nations like Australia, pushing inventories to a 30-year low. Coffee prices jumped, thanks to the opposite weather conditions, as rain in Brazil may curtail harvests.

Things are tight in the petroleum and minerals groups as well. Older oil fields in the Middle East and Latin America are losing production faster than anticipated, and producers can't bring new supplies on line quickly enough. Strikes and production delays threaten supplies of ordinary metals such as copper and nickel.

"Worst Commodity Inflation in Years"

The rising prices also have hit the stocks of companies that rely on commodities, especially in the food industry. ConAgra Foods (CAG), General Mills (GIS), and Del Monte (DLM) have all sold off in mid-September as executives reported no end in sight to rising costs. ConAgra Chief Executive Gary Rodkin told analysts on Sept. 20 that inflation for some of his company's most important ingredients was "through the roof." "We are witnessing some of the worst commodity inflation in many, many years," Heinz (HNZ) Chief Financial Officer Arthur Winkleblack said after his company's most recent quarterly results.

The interest rate cuts by the Federal Reserve have also helped push commodity prices higher. On the one hand, the cuts make a recession less likely, thus bolstering demand for commodities. And the cuts also encouraged currency investors to further sell off dollars. Since many non-U.S. commodity producers still price their exports in dollars, a weaker dollar prompts them to seek higher prices.

In the energy patch, there's no question that some of oil's recent meteoric rise was fueled by short-term speculators. In the next few months, oil is likely to sell off as U.S. demand for gasoline typically wanes at the end of the summer and most forecasters are calling for a mild winter, says Tim Parker, an energy analyst with mutual fund firm T. Rowe Price (TROW) in Baltimore.

Still Going for Gold

But the inability of the world's producers to find new cheap sources of oil spells the end of the days of $20 or $30 a barrel oil. "You can't look out to the future and feel confident that there's a lot more oil coming," says Parker. "Even the days of $50 or $60 a barrel oil may be gone now."

Gold has benefited the most from the dollar's decline. Long seen as a safe haven in times of turmoil, the metal also has gained thanks to the fear gripping investors since the subprime mortgage mess started spreading. European and Asian investors who were burned by subprime debt have moved some of their assets to the safety of gold, says Frank Holmes, chief investment officer at mutual fund firm U.S. Global Investors. "Things have really picked up since the financial crisis hit in August," Holmes says, pointing to money flowing into gold funds as well as the runup in the price of gold. Shares of gold producers such as Barrick Resources (ABX) and Newmont (NEM) have also benefited.

Can the boom times continue? Of all investors, commodity players should be acutely aware of how quickly things can change. The biggest risk for commodity investors is the possibility that the slowing U.S. economy craters, dragging the entire world into a major recession. But the U.S. slowing by itself isn't likely to have as dramatic an effect as it once did. Most of the increase in demand for commodities has come from Asia and the Middle East. "You have to think globally now," says T. Rowe Price analyst Parker.

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