Commodity Crash: How US recession will affect the commodities supercycle

Posted January 26, 2008

'Probably over the next few months we’ll see some downside volatility in oil and in gold because of the concerns about global growth. Energy more so than gold because the dynamic behind gold has more to do with the declining U.S. dollar and worries about inflation.' — Mike Burnick, editor of Global Market Investor

Baltimore – (TFN): The following was taken from Mike Burnick's appearance on this week's Smart Trading Action Alert hosted by Laura Cadden. Watch this video.

Laura Cadden: Throughout 2007, the commodities super cycle pushed resource prices to record levels. Crude oil surged 44 percent, gold called up with historic highs, while wheat prices doubled. Base metals also performed strongly, driven by consumer demand as well as a global construction boom. Copper prices, for example, have quadrupled in the past five years.

But expectations for a recession in the United States are now hitting the commodities market. Oil and gold may yet be relatively unaffected, but base metals have corrected sharply, with copper prices plummeting 20 percent since early October.

My guest today is Mike Burnick, editor of Global Market Investor.

So, Mike, do you believe consumer spending is about to stop?

Mike Burnick: Well, that’s a great question. It’s been much debated. The American consumer has been so resilient over the last few years, but finally, some of the data we’re seeing recently indicates the U.S. is probably already in recession and has been.Certainly if you look at the manufacturing data we’ve seen recently, the employment numbers indicate a worsening of the U.S. economy.

Then just yesterday we saw retail sales for the month of December were down almost a 0.5 percent — the worst December in years. As a matter of fact, 2007 as a whole saw the worst retail sales numbers in at least five years. It indicates to me that finally the American consumer is keeping their purse closed and keeping their hands in their wallets. They’ve stopped spending here.

Laura Cadden: In U.S., credit expansion and the increase in household debt has occurred simultaneously with the incredible economic boom in both China and now India. What kind of effect do you think a drop, such as we’re seeing now, is going to have, for example, on China?

Mike Burnick: That’s been a very hotly debated topic. What we’re talking about really is decoupling, which is the ability of these emerging market economies to continue growing at a steady pace. Even if the U.S. falls in a recession and it’s a deep one, if Europe slows down, can the emerging markets continue to grow?

Now, I see a lot of evidence that that will, in fact, be the case. Certainly, obviously, countries like China, as a for instance, about 40 percent of their total exports still go to the U.S. and to Europe. So if we see a really bad recession here in the U.S. and if we see a sharp slowdown in Europe as well, China is going to be affected. There’s no doubt about it.

But that said, we’re seeing a tremendous growth in that area of the world. As a matter of fact, last year, for the first time in history, the emerging economies became the leader driver of global growth. China kicked in about 30, 35 percent of the world’s total expansion in 2007, which is unheard of. India kicked in another 11 percent. The U.S. and Europe, by contrast… they used to be the leaders, but not anymore. They only grew about 7 percent each in terms of their contribution to the worldwide total.

So the baton has really been passed from the developing countries like the U.S. and Europe to these emerging markets. That’s why I think we could probably see continued strength there.

Laura Cadden: Now, let’s talk about copper, for a moment, since it’s dropped 20 percent. What do you see as the ultimate downside is for this metal, and what other commodities do you think will be affected?

Mike Burnick: Well, as you mentioned at the top of the show, copper prices have already come down a lot, about 20 percent just since the summer or early fall. And all the base metals have corrected. If you look at zinc, aluminum, lead, all of these metals that are used in the industry a lot have slowed down because of these concerns about a slowing global growth.

I think that’s probably going to affect other commodities as well. There’s going to be a spillover affect. Gold has been strongly leading, but I wouldn’t be surprised to see a correction there. As you mentioned, gold prices are up about 200, 250 percent over the last five years. So a lot of the easy money has already been made. Crude oil is up about 250 percent just since 2001 or 2002.

So it’s not a bad idea, I guess, to take some money off the table and take some profits. I think probably over the next few months we’ll see some downside volatility in oil and in gold because of these concerns about global growth. I think energy more so than gold because the dynamic behind gold has more to do with the declining U.S. dollar and worries about inflation. That helps to prop gold prices up a little bit more.

However, that said, as I said, all commodities really have been moving higher because of the booming global growth. If that slows a little bit at the margin, commodities will probably correct.

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Laura Cadden: Now, what do you think is the least risky way for traders to play this downturn?

Mike Burnick: Well, in my investment research newsletter, Global Market Investor, I play ETFs a lot. Exchange traded funds have really come a long way over the last five years, the heavy ETFs. These days it lets you play any sector or investment style of the market, and literally, dozens and dozens of emerging markets and international markets around the world can be invested in just using ETFs.

In one single trade, you get instant diversification off different sectors, hundreds of different stocks, even different regions of the world. One of the most interesting things with ETFs recently, just over the last year or so, they’ve started introducing what they call inverse ETFs, which are designed to actually go up in value whenever the index they’re tracking goes down.

Now, they have these on commodities as well. So it used to be that if you wanted to play commodities markets you had to buy the physical commodities, which meant opening a futures account. If you wanted to play foreign currencies you have to have a forex account.

Not any more. Now, with ETFs and a standard brokerage account, you can use them. Even an IRA for that matter, you can buy ETFs that gives you upside exposure as well as a hedging or a downside protection from a market decline. And they have these on energy.

As a matter of fact, I’ve recently recommended one, which is called the ProShares UltraShort Energy ETF. Now, that tracks a lot of the big energy stocks, like Exxon Mobile, Chevron Texaco. If these stocks decline in value, this particular ProShares ETF would go up. The symbol on that, by the way, is DUG.

There’s also another one that follows crude oil itself, the actual commodity. So that, by the way, is called MACROshares Oil Down, which is a simple explanation — if oil goes down, you profit. That particular fund is tied to commodity futures, but again, it can trade in your ordinary IRA account. You can invest it and put it away. That particular fund has actually been shooting up a lot over the last – just the last week or so because oil has been coming off a bit from $100.00 a barrel down around $92.00 or so now.

To learn more about Mike Burnick's investing research service, Global Market Investor, click here.

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