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Skeptical Capitalist / Vad Yazvinski8/4/2008 12:01 AM ET

The end of the commodity run?

The Wall Street herd is rapidly changing direction, but that doesn't necessarily mean that you should buy all the most beaten-up stocks and expect them to skyrocket.

  • Buy $6,000 worth of Fushi Copperweld (FSIN, news, msgs) at the open.

  • Buy $8,000 worth of China Natural Gas (CHNG, news, msgs) at the open.

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"The trouble with most people is that they think with their hopes or fears or wishes rather than with their minds." -- Will Durant

Ever since the buy-natural-resources-sell-financials strategy went mainstream last year -- driven by excess liquidity created by the trigger-happy Federal Reserve -- the prices of most commodities and natural-resource-producing companies seemed to leave the realm of fundamentals and enter an era of two new ideas:

  • Buy tangible resources at any price.

  • Expect what went up recently to go much higher.

"The world could absorb all the steel, iron ore, corn, wheat, oil and gasoline produced in the world, virtually at any cost" -- or so said the news media.

The fact that growth of the U.S. economy has slowed to virtually zero never really bothered the commodity bulls. Terms such as "decoupling" and talk of millions of new Chinese and Indian middle-class consumers were thrown at anyone who questioned the validity of $145-a-barrel oil.

But behavior-changing $4 gasoline and a corresponding drop in gas demand seem to have finally overpowered the world-is-running-out-of-everything stories. The commodity run certainly appears to be on life support today.

I could still turn out to be wrong, and commodities could stage another major run, but at least for now, Wall Street's lemminglike behavior is now rapidly swinging the other way.

The tricky part

So what does it mean for a regular investor? That's where the tricky part comes in. The fact that value investing is starting to make a comeback does not necessarily mean that you should buy all the most beaten-up stocks and expect them to skyrocket.

The Wall Street Journal noted last month:"By the end of June, a model portfolio of momentum stocks had returned 71.3% year-over-year, while a model portfolio of value stocks with high book-value-to-price ratios was down 54.8%, according to Joseph Mezrich, head of quantitative research at Nomura Securities."

But looking at the chart provided with the Journal article led me to an interesting observation: The last two times when momentum strategy has spiked and outperformed value by such a drastic margin was at the peak of tech bubble and then right before the markets' 2003 bull market.

Obviously, the outcomes of these two events were drastically different, and thus correctly predicting which way markets are going to head this time is what one needs to do to stay ahead during the next six to nine months. I have not yet made my own final judgment (I'm leaning toward a more bearish scenario for now) and probably won't be able to do that until the current technical-analysis-driven rebound runs its course.

Finding stocks that fit my short-selling criteria has been quite tough recently. Usual consumer discretionary short suspects are jumping up and down for no apparent reason and seem to be trading based purely on the amount of short-covering going on. So for now I'll just roam along with a predominantly long portfolio dominated by lower-beta stocks and some recession-resistant sectors such as health care and waste management.

It's becoming more obvious every day, however, that many other countries' economies are rapidly entering a severe slowdown. And thus if U.S. corporate profits and exports deteriorate along with them during the next several months, I'll add a lot more shorts to my portfolio.

For now, stay safe out there. Please visit my blog, The Skeptical Capitalist, or e-mail me at skepticalcapitalist@gmail.com. I also hope to see some of you in person at The Money Show in San Francisco.

Meet the strategists at The Money Show

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Can't make the show? The Strategy Lab panel will be webcast live from 10:45 to 11:30 a.m. PT Friday, Aug. 8. Click here to register now, then return for the webcast.

Vad Yazvinski and skepticalcapitalist.com are not investment advisers and are not recommending any securities or other investments to individual readers. Yazvinski and/or entities affiliated with him have in the past traded stocks mentioned in this article and may do so again in the future. At the time of this writing, Yazvinski has held positions in most securities mentioned in his mock Strategy Lab portfolio.

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