Short-Term Key: Positive

Long-Term Key: - 95 (Negative-to-Neutral)

 

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Inside this New Year's update...

 

***** America loses control of its fate.

***** A rundown of key commodities for this year.

***** Currencies that will outperform the dollar.

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Typically at this time of year, investors try to step back a little and look at the big picture. Of course, as one of our readers, the big picture should be familiar ground to you. Nonetheless, some pretty important stuff is emerging from over the horizon that warrants another look.

The big story of 2009 and indeed the entire 2000s has been the rise of the developing world over the United States. A number of trends evidence this shift. You can see this has occurred by looking at changing figures on the supply, demand, and price of oil.

Today, U.S. oil consumption remains close to what it was ten years ago. Yet oil prices are four times higher. What's more, despite U.S. unemployment rising to 10%, oil prices are nearly 100% higher than they were a year ago.

As you must know by now, a 100% year-over-year rise in oil prices heralds a bad period for the economy and the markets. It reminds investors how dependent America is on oil imports, and cuts into corporate profits. We will see over the next few days if oil prices hold this level and let you know our recommendations if they do.

Of course, it may take financial commentators a while to catch on. One blog we read over the weekend actually applauded that gasoline prices stayed under $3.00 this year. Well, if you had asked people five years ago how much gasoline would cost if unemployment hit 10%, the highest estimates would probably be $1.50, due to weak demand. Yet even with many consumers conserving gasoline today, prices are very high.

This is bad news, since high gasoline prices effectively tax the consumer, decreasing spending on other products and services. More to the point, the conundrum of rising prices and stable demand tells us that oil prices are not being driven by U.S. consumption but by growing demand from the rest of the world, particularly the developing nations.

It also tells us that all the hype about natural gas being the next big commodity to go through the roof may not be as obvious as it seems……

 

 

GAS

 

Natural gas has become the new favorite commodity for commentators to be bullish on, simply because it has lagged badly behind oil and virtually all other commodities. We don’t think this is a good way for framing the bullish case for gas, especially if the U.S. economy doesn't pick up sharply.

You see, unlike oil, natural gas is a nationally produced and consumed commodity. Its price is determined almost solely by domestic rather than global supply and demand. Rising gas consumption in China really doesn't affect U.S. gas prices. Remember it is very difficult to substitute gas for oil – unless there is a major infrastructure build out.

Still, we are a little more optimistic about gas than we have been in the past, because it can replace coal to some extent – and because it would be more environmentally friendly to replace coal with gas. Also, as we pointed out in past updates, we think U.S. shale gas reserves have been overstated because shale gas will be harder to extract than people think. Once that becomes obvious, it too will help gas prices.

However, gas prices (unlike oil) depend on a healthy U.S. economy. Any commodity-driven setback in the U.S. economy – or even low growth - would hold gas prices down.

As for our other favorite commodities...

 

 

Not that gold needs another catalyst to drive its price higher, but any sign of weakness in the U.S. economy this year could easily send gold prices through the roof. Such weakness would prompt the Fed to instigate more quantitative easing to get the economy moving. One side-effect of that would be to weaken the dollar and strengthen gold.

Interest rates have moved up substantially since the Fed stopped buying paper. Moreover, much of the government's economic stimulus efforts have already been spent. So the consumer right now is facing a triple-whammy of higher oil prices, higher interest rates, and a decline in stimulus. That doesn't bode well for the economy, but it does for gold.

 

COPPER

 

One other commodity that demonstrates the developing world's ascendancy is copper. Traditionally, copper prices were closely linked to the U.S. housing market. When housing starts rise, demand for copper (used to make wiring and plumbing) grew. Similarly, copper prices fell when the housing industry weakened.

Recently, however, that relationship has evaporated. We've just gone through the biggest housing slump since the Great Depression. Yet, at over $3 a pound, copper prices are not far from their all-time high. What's more, they are more than 3 times higher than they were in 2000, when U.S. housing starts were many times greater than today.

Once again, this implies the U.S. is no longer in control of its own economic destiny. In past periods of economic weakness, we could count on commodity prices falling, which reduced inflationary pressures and encouraged growth. When the economy grew too quickly, commodity prices rose and helped put on the brakes.

Today, we see the opposite taking place. Commodity prices remain strong despite economic weakness. Meanwhile, the Fed is forced to follow the same old policy: keeping rates low during times of recession. But that means nothing can keep commodity prices and inflation in check.

 

THE U.S. DOLLAR

 

Increasingly, we are seeing signs that the U.S. dollar is responding to commodity prices, rather than the other way around. In last night's trading, for instance, we noticed gold prices rising at the same time as the dollar. By the time morning came around the dollar was following gold – i.e., gold was soaring while the dollar was tanking. That may be only one incident, but it's one of many – and one of many signs that the U.S. economy and our dollar have grown vulnerable to commodity prices. It's also one of many signs that the traditional inverse relationship between gold and the dollar may be breaking down.

Whether the dollar rallies or falters now, commodities seem poised to go their own way – and that way is up. We expect the currencies of resource-rich nations (the BRACC nations) will do well versus the dollar this year. We also expect markets will be volatile, but that you will be rewarded for owning gold, silver, copper, and other commodities.

True, copper prices do depend on rising Chinese demand, but we expect China's building campaign will continue unabated. In one article we came across recently, a group of Chinese economists expressed their worry that Peak Coal production will occur within 15 years. Already, China is importing coal to meet its energy demand. The nation needs alternative energy in the worst way, and has started building the massive infrastructure required – but it has trillions of dollars to go. The effort should keep the price of copper (and most industrial commodities) on the upward track.