Beware commodity boom

Money Talk

Your Money

April 18, 2004|By MATT LUBANKO

I keep hearing about rising prices for oil, natural gas, gold, silver, tin, steel, copper and other commodities. With prices rising so consistently - and across the board - would now be a good time to invest in stocks of companies that produce commodities or in mutual funds that invest in these commodity-producing companies?

- R.L., Chicago

Ask the analysts who follow the commodities markets, and many will tell you the current rally could last for several more years.

Inventories are low. Reserves are supposedly dwindling, at least with petroleum. Demand is growing, especially in China, and stepping up production to meet this recent surge in demand could take several years.

"Economic growth has slowed since 2000, yet average oil prices have risen from about $20 a barrel in the last decade to $28 a barrel in this decade. That tells us we're not in Kansas anymore," said Stephen Leeb, co-author of The Oil Factor: Protect Yourself - and Profit - From the Coming Energy Crisis.

Commodity-related investments have thus become a clear favorite in recent years, despite the sell-off last week. They are held in increasingly large quantities by the largest mutual funds. They are seeing increased attention through so-called sector funds: mutual funds that invest mainly in one or two industries. And many financial advisers have rightly steered clients to commodity-related investments.

Despite these and other developments tied to rising commodities prices, investors should be forewarned. No rally lasts forever. And no forecast is flawless, no matter how intelligent and well-informed its source - and no matter how good that source might look on TV.

Just the same, it's wise to know why this rally is under way. And it's equally wise to know what could lead to its undoing.

Start with the notion that the prices of most commodities, especially oil, are tied to the supply end of the equation. And supplies have grown tight because production growth has slowed, stalled and in some cases retreated for the past 10 to 15 years.

"For a long time, prices weren't strong enough to encourage new investment," said Victor Lazarovici, an analyst with BMO Nesbitt Burns, a firm owned by the Bank of Montreal.

When commodities prices are low, companies produce less. When prices stay low for a long time, companies shut down mines, processing plants or natural gas and oil wells and refineries. Though the story varies greatly from commodity to commodity, such retrenchment has taken place in many sectors since the late 1980s, Lazarovici said.

This pullback in production cannot be erased overnight, Lazarovici said.

It can take 18 months to three years to create a new mine or drill a new well. Companies have to select production sites. They have to receive permits to develop those sites. They have to buy machines that extract the minerals, and they have to find and hire workers to operate those machines, Lazarovici said.

"Major oil wells can take three to five years to get started," said John Gerdes, an analyst with Southwest Securities in Dallas.

But markets are markets, and they have historically corrected supply-demand imbalances with little notice. Mineral discovery and extraction technologies, furthermore, have improved in recent years. And relatively new players in the global market - Russia, the former Soviet republics, China, and many in Latin America and Africa - can and will rush to produce all they can while prices are still high.

These unseen forces make it a wise policy to never assume, as some have hinted, that prices will rise indefinitely. They never do.

Did yields on the 10-year U.S. Treasury note reach their low last June?

- U.S., Simsbury, Conn.

Nobody knows. While yields on the 10-year U.S. Treasury note touched 3.14 percent last June - and have surged well above 4 percent in recent days - it's foolish to say rates "cannot go lower" because they haven't reached these levels before.

Just look at Japan. There was a country that enjoyed a stock market and real estate bubble in the late 1980s. And there is now a country that, in an effort to revive a chronically languid economy, has held rates to unimaginably low levels. How low?

Yields on the Japanese equivalent of the 20-year Treasury dipped to 0.8 percent last June. And yields on shorter-term government debt in Japan actually fell below zero. The United States is not Japan, to be sure. But Japan has shown us that "historically low" interest rates can fall even lower.

Matthew Lubanko is a financial columnist for The Hartford Courant, a Tribune Publishing newspaper. E-mail him at

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