A Soft Sell on Hard Commodity Assets

Even though steroids have been banned, sort of, in baseball, spring is arriving, and the sap is rising both in maple trees and elsewhere. Natural impulses, combined with the first sustained commodity price rally in a quarter-century, have led to proclamations such as "Copper prices can go anywhere."

I normally will do my part for young love, but to ignore both history and economics simultaneously in the process is simply asking too much. Neither copper nor any other physical commodity can move beyond bounds defined by the operating margins of copper buyers on the upside and copper miners on the downside. As I noted in January 2002, commodity price rallies and downturns are self-correcting.

The present higher prices for copper will encourage both substitution and outright demand destruction and will eventually lead to mine expansion. Just as the world is chock-full of methane, it is chock-full of copper and other metals in deposits such as seafloor manganese nodules, which are uneconomic amid present price, technology and international legal structures.

If you are looking for prices capable of going anywhere, look to individual equities. They are capable of rising several hundred percent a year, or falling 100% in a short period. Even equity indices can move further and faster than individual commodities, as the comparative price chart of copper and the Dow Jones Industrial Average, sans reinvested dividends, over the past century clearly depicts.

Do you have a need for speed? Bet on the tortoise of stocks, not the alleged hare of commodities.

Which Market Can 'Go Anywhere'?

Source: CRB-Infotech

Commodity-Linked Equities

If the capacity to add value lies with the commodity's producer, processor and distributor rather than with the commodity itself, a theme emphasized frequently in this space, then commodity-linked equities should be tempting. The Goldman Sachs Resource Index (GSR), the basis for the iShares exchange-traded fund (IGE), can serve as a reasonable approximation for such equities, even though its composition is of necessity skewed toward the oil and gas sector, with no distinction made among producers, refiners and integrated firms.

Goldman Sachs Resource Index Industry Composition

Source: Bloomberg