Commodities in Bull Market Mode

In the last month or so, commodities have been on a bull run. The Standard and Poor’s GSCI gauge of 24 raw materials has jumped about 24 percent from this year’s lowest close of 559 on June 21. A gain of more than 20 percent is the commonly recognized definition of a bull market.

There have been several reasons for the broad surge in commodity prices. One is the monetary stimulus launched by both the United States and Europe. The Federal Reserve has announced QE3, where it will begin an open-ended program of purchasing $40 billion of mortgage-backed securities every month. In Europe, the ECB said it would make unlimited purchases of the government debt of the troubled peripheral countries of Europe. In addition, some emerging market countries such as China have again announced a stimulus plan, spending billions of dollars on items including infrastructure.

But in many cases, there have also been strong fundamental reasons behind the rise in commodity prices. With oil, for example, turmoil in the Middle East and North Africa brought on by uprisings (Arab Spring) have raised legitimate concerns about not only the supply of oil from the region, but also its cost as regimes in the region, such as Saudi Arabia, increase domestic spending in an attempt to appease its citizens.

Then we have the grains, the strongest performing subsector in commodities thanks to the worst U.S. drought in half a century. The drought has slashed production of corn and soybeans at a time when demand for the grains from China and other emerging markets is increasing. The jump in grains and oilseeds sent world food prices up 6.2 percent in July, the biggest increase since November 2009, according to the United Nations Food and Agricultural Organization. The FAO’s gauge measures 55 food items worldwide.

Conditions are unlikely to improve any time soon. The U.S. Department of Agriculture has slashed its corn harvest forecast 27 percent just since June. Crops are in their worst condition since the 1988 drought (which cost U.S. farmers $78 billion in damages) when the corn harvest tumbled by 31 percent. The USDA now expects U.S. corn production to drop to at least a six-year low at 10.78 billion bushels and soybean harvest to be its smallest since 2007, at 2.69 billion bushels.

So there are myriad reasons for the rise in the prices of many commodities. Some are fundamental such as with the grains and oil, while others are driven mainly by global monetary conditions. It is unknown whether the bull market will continue. But remember one thing: the stated purpose of the Federal Reserve’s QE is to raise the price of financial assets; and commodities, through futures trading, can today certainly be considered financial assets.

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