Are Commodity ETFs Bursting?

With the commodity markets having it taken on the chin last week, this may be a good time to review what famed investment manager Jeremy Grantham had to say about this sector a week or so ago.

Here’s his view, as well as the markets in general, in “Bad China, good weather will bust commodity market ‘en masse:’”

Jeremy Grantham said there is a 25 percent chance that China, the world’s second-largest economy, will “stumble” by next year over imbalances such as too much capital spending, an overheating real estate market or accelerating inflation.

“You could have a financial stumble, a housing stumble, a stumble from rebalancing of capital spending, or any combination thereof,” Grantham, chief investment officer of Grantham Mayo Van Otterloo & Co., said in an April 26 interview in Boston.

China’s economic growth may “slow to considerably less” than the 9.7 percent pace reported for the first quarter, Grantham said. Inflation accelerated to 5.4 percent in March, the fastest pace since July 2008, adding more pressure on officials to tighten monetary policy.

Grantham, 72, is best known for his bearish outlook and for spotting asset bubbles early. He correctly forecast in 2000 that U.S. stocks would decline in the coming decade, and as early as July 2007 predicted that a large global bank would go bust amid credit market declines. He recommended buying U.S. stocks for a five-month period starting in early 2009 in what he called “my very short life as a bull.”

“I find it intellectually convincing,” Grantham said, referring to the idea that China’s economy will slow. Still, “they have the ability to get everybody to change the game on a dime.”

In an April 25 letter to investors, Grantham said that a decline in China’s economy would hurt the commodity markets. If a Chinese decline were accompanied by better-than-expected weather globally, then “it will very probably break the commodity markets en masse,” he wrote in the letter.

“If the weather and China syndromes strike together, it will surely produce the second ‘once in a lifetime’ event in three years,” Grantham wrote.

Despite some short-term shocks, global demand for energy, metals and crops is outpacing supply, Grantham said, creating “brilliant long-term prospects” for commodities.

Grantham said in January that the U.S. stock market rally is living on “borrowed time,” driven by low interest rates and the Federal Reserve’s unprecedented stimulus. The Standard & Poor’s 500 is worth about 920, Grantham said in the interview, about 32 percent below where it is now. When the Fed eventually “runs out of money,” the U.S. stock market will fall, Grantham said.

“I’m not good at timing,” he said. “Sooner or later, it will happen,” he said.

[Emphasis added]

Commodities can be especially volatile, as the above chart showing the commodities index DBC, clearly demonstrates. Huge rallies are usually followed by just as dramatic collapses, and the use of a sell stop is essential to lock in profits, if you have been participating in the up move for a while.

Weather related incidents, along with an overheating economy that needs to be slowed down, such as we have in China, can cause demand issues affecting the direction of commodities in general. Too many fundamentals can play a role, so it’s best to simply watch the trends and act upon them.

At least for the moment, DBC sharply reversed this week triggering our 10% trailing sell stop as posted last Friday. We closed out all positions and those, which we had held all year (see model portfolios), ended up being very profitable, despite the sudden reversal.

Grantham’s final comment (see highlighted paragraph) is spot on and goes along with the same theme I have been harping on for over a year. The unknown is just the timing of it.

If you simply follow the trends in the market place, as I advocate, you will notice when a reversal is in the making. Trust the sell stop discipline, even if it gets you out of the market too early. Being early is far better than being too late.

The Fed’s QE-2 program is scheduled to run out the end of June. If economic conditions have not gathered enough steam to make up for the Fed ending the stimulus, no one can say with any certainty as to what will happen next.

Always prepare your exit strategy way ahead of time, preferably when the markets are calm, so you won’t be stressed when the heat is on.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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