Investment Outlook - The Risks Ahead December 17, 2009, 5:00PM EST

The Case for Commodities

They could be a smart inflation hedge in 2010. And some pros see a long-term bull market for oil, grain, and gold

By Lewis Braham

Browse Issues

Browse the BusinessWeek Archive

Related Items

Story Tools

Oil, gold, corn, wheat—perhaps the most attractive thing about commodities is they seem so concrete. Investors know that a barrel of oil may be worth more or less at the end of the day, but it will never disappear. In an age when major financial institutions can go bust overnight, that holds a lot of appeal.

Since most commodities are priced in U.S. dollars, 2010 may be a good year to invest in them. That's because the Federal Reserve has kept interest rates close to zero and increased the money supply dramatically, a move some experts say will ultimately devalue the dollar and spark inflation. As the amount a dollar can purchase decreases, commodity prices rise in relative terms. "Inflation usually starts by the government printing too much money," says Victor Sperandeo, a commodities trader and developer of a commodities index called the S&P Commodity Trends Indicator (S&P CTI). "Never in its history has the U.S. printed more money. When inflation becomes visible, we will start to see stocks slow down and commodities accelerate."

Historically, commodities have proved a better short-term hedge against temporary inflationary shocks than a good long-term investment. "Commodities are cyclical," says Sperandeo. "Corn goes up and down in price. It doesn't only go up. If you held nothing but corn in your portfolio from 1930 on, you'd have only a 2% annualized return, compared to 9% for stocks." For this reason Sperandeo developed his S&P CTI index, which follows short-term trends in commodity futures, investing in those with positive trends over the past seven months while shorting, or betting against, those with negative trends.(The strategy isn't unique, but building an index product around it for individual investors is.) Because of this ability to hedge, the CTI was up 17.7% during 2008's market meltdown. The new Direxion Commodity Trends Strategy Fund tracks the index.

Yet some money managers say there is a case to be made for a long-term commodity bull market. "Historically, commodity prices have tended to decrease by 1% to 2% annually because of improvements in the technology used to harvest commodities," says Samuel Fraundorf, co-manager of the Wilmington Multi Manager Real Asset Fund (WMMRX), a fund that invests in commodities, real estate stocks, and inflation-protected bonds. "But you have to juxtapose that with the fact that the world population continues to increase, and standards of living in emerging countries such as China and India continue to improve at rates much faster than the natural decline we've seen in commodity prices in the past. These countries have a voracious demand for commodities."

SUPPLY SHORTAGE

Couple increased demand with the fact that during the recent downturn capital wasn't available to develop the infrastructure to drill for more oil, dig more iron, or grow more corn, and you see how a supply shortage could occur when the economy recovers. Figuring out where the shortages will be is the main challenge. "We're focusing on commodities where the ability to increase supply has been difficult—oil, copper, iron ore, and coal," says Jerry Jordan of the Jordan Opportunity Fund (JORDX), which has beaten 99% of its fund peers in the past three years largely thanks to a 25% exposure in commodities.

Jordan says copper stocks have rallied too hard of late and are now overvalued, but he is still a big fan of oil. He likes offshore drillers Transocean (RIG) and Diamond Offshore Drilling (DO). "If you want to find more oil in the next decade, it will have to come from offshore drilling, and these companies are trading at ridiculously cheap levels relative to the value of their assets," he says. "Transocean trades at about seven times forward earnings and is an 83 stock.