Speculators fuel commodity boom

By Tim Middleton

Welcome to the newest bubble: commodities.

When a market's most knowledgeable players are eager to lock in today's prices for their wares, they are shouting that tomorrow's prices will be lower. And they're eager:

"Professional hedgers who sell their production forward have never sold as much future production forward as they currently have," says Stephen Briese, the author of "The Commitments of Traders Bible."

A front-page article in Barron's recently argued that prices across commodity markets are set to plunge 30%.

The reason: Though much of the recent boom is driven by rising demand for such basics as food, minerals and oil, much has also been driven by pure speculation, thanks to the ease with which amateurs like you and me can buy into these markets via exchange-traded funds. Roughly a third of long commodity positions are owned by ETFs and other index-linked portfolios.

The Commodity Futures Trading Commission is concerned enough to be holding a hearing today in Washington, D.C., about rampant speculation in agricultural commodities. In addition to individuals, hedge funds and other professionals are fueling explosive growth in commodity-linked ETFs.

An impressive rally

The ETFs are chasing performance, and many experts think commodities' strong performance will long persist. Hedge fund legend Jim Rogers -- whose name is used on some commodity indexes and ETFs -- has characterized today's commodity markets as being in the fourth inning, or early in what is already a huge bull market for energy, grains, and industrial and precious metals.

The average natural-resources mutual fund has shot up at 31.8% annually in each of the past five years, according to Morningstar. That's more than three times the gain of the average large-company growth fund, the most popular kind.

Predicting the end of this bull market has frustrated plenty of analysts, including me. In November, I called $95 a barrel for oil a "bubble price" and said you should "cash in your oil profits now."

Last week, the price was touching $116.

I took my own advice and sold a portion of my holdings of T. Rowe Price New Era (PRNEX) for $64.50 a share. Last week, the shares were trading at $65.44, and they paid a handsome dividend in December as well.

Fortunately, I held on to most of my holdings of that fund, and it accounts for 7.4% of my portfolio. I also own iShares S&P GSSI Natural Resources (IGE, news, msgs), as does the MSN Money Model ETF Portfolio that I run. Agricultural-commodity ETFs and a small position in gold bring my personal exposure in commodities to 14.6% of assets.

(By the way, I probably fit the commission's definition of a speculator, but I don't see myself that way. I think commodities are an alternative asset class, like commercial real estate, with a low correlation to stocks and bonds. That makes them useful diversifiers as well as attractive investments on their own.)

Genuine demand, tempting targets

While I understand Briese's concerns and expect plenty of volatility in these positions, I think the secular bull market in commodities will continue for the foreseeable future. The world's appetite for these things is increasing.

A portion of the rising global demand is frankly stupid and could disappear if it weren't so politically correct. Growing corn for ethanol is hugely wasteful, and we could buy biofuel from Brazil if we weren't married to domestic farm-belt subsidies. The European Union is just as wrongheaded.

But a larger portion of global demand for commodities is genuine. The developing world, including Russia, is both the source of many of these goods and the source of demand for them. These nations need to satiate their growing middle classes while they build out their infrastructure.

Layered atop this genuine demand is demand that derives strictly from speculation. ETFs such as PowerShares DB Agriculture (DBA, news, msgs) and iShares Dow Jones US Energy (IYE, news, msgs) and exchange-traded notes like Elements Rogers International Commodity (RJI, news, msgs) give amateurs access to very small marketplaces traditionally utilized only by professionals for their own livelihood.

Continued: The dollar's dive

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