There’s conventional wisdom and then there’s conventional wisdom. JP Morgan recently reminded investors that as inflation rises, commodities tend to benefit, especially base and precious metals. Apple Inc. (NASDAQ:AAPLB) has noticed and was in the news recently regarding its efforts to buy cobalt (you know, for phone batteries) directly from miners.
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3 Stocks To Consider
Given what could be a trend, Michael Kramer, founder of Mott Capital Management LLC, suggested 3 commodity players he believes have a bright future in the current climate.
BHP Billiton (NYSE: BBL) is a miner that Kramer expects to advance as much as 20% to $56 if conditions are right. Rio Tinto (NYSE:RIOC) is an iron-ore miner that recently broke out of a multi-year downtrend and, Kramer says, could rise above $60, even 20% to $72. Finally, Freeport McMoran (NYSE:FCXB), a copper miner with potential to rise all the way to $24 provided it can rise above current resistance at $19.75. The key for all 3 stocks will be inflation and whether it drives metal stocks higher.
Late Cycle Rally
On a recent CNBC “Halftime Report,” bond investor, Jeffrey Gundlach said he was a big believer in commodities as an investment. Said, Gundlach, "I still like commodities. I think [in the] late cycle commodities always rally." According to Gundlach, the current economic expansion is one of the longest in history. He noted that in previous cycles, commodity prices surged as much as 400% at this stage in an economic cycle.
Since most investors are underweighted or not invested in commodities at all, Gundlach says, they represent a way to get diversified at low prices. His take represents a pro-commodity view from the fixed income side of investing, an area for which Gundlach is most well-known.
Commodities are the ultimate consumables. Rising interest rates tend to pull capital away from stocks and if the rise is inflation related also from bonds. The inflation that eats away at the value of money tends to cause the prices of raw materials – those ultimate consumables – higher. In some cases, prices skyrocket.
Commodities are local. Copper comes from Chile, oil the Middle East, corn and soybeans the U.S. and sugar, coffee and oranges are produced in Brazil. Not exclusively, of course, but as a generalization these points of origin are true. No matter where commodities come from, people consume them nearly everywhere. In times of higher inflation commodities become an alternative investment.
Why Commodities Will Rise
Among reasons why commodity prices rise, first the dollar. As the dollar index declines, the price of commodities rises, generally speaking. With the current price of the dollar bearish versus other world currencies, more gains in the price of many raw materials is likely. Second, the afore-mentioned inflation. Inflations eats away at the value of money causing the prices of all goods and services, including commodities, to rise. Divergence between the dollar and higher interest rates could be a harbinger of inflation which, as already noted, could raise the price of commodities. Finally, the hallmark of capitalism – supply and demand. There are more people demanding more commodities and the only possible outcome is higher prices as demand outpaces supply.
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A Note Of Caution
There’s always a note of caution. This one is simple. Commodities are not a homogenous asset class. Individual commodities often have little to do with each other. As a result, historically not all commodities are good inflation hedges.
Duke University research several years ago found, in fact, that just 3 of 12 commodities for which futures were traded were positively correlated with inflation. Among commodities that have historically correlated with inflation, energy is king. Coincidentally, gold and precious metals have a spotty record when it comes to correlation with inflation.