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By: Costas Bocelli — October 27, 2010

How Investors Can Participate in the Global Commodity Rally


Active traders love hot markets with plenty of volatility and volume that generate frequent trading opportunities.  And the action in commodities has been fast and furious, leading the headline news regularly.

Long term investors should think about getting some exposure in commodities as well.  A balanced, diversified portfolio is the key to wealth preservation, and a natural hedge to broad-based market volatility.  Having significant exposure to the Earth’s precious resources over the long term makes perfect sense.

It's simple, really:  This planet isn’t getting any bigger, but population growth continues to expand globally.  Developed markets have been the primary consumers of natural resources, but that trend is changing quickly as emerging markets continue to grow quickly and are competing for the same limited resources.  The simple law of economics -- supply and demand -- suggests that the value of these resources must increase.

Accentuating the importance of this investment in your portfolio is the protection it affords against inflation and currency devaluation.  Global commodities are traded and priced in US Dollars, the world reserve currency, and commodity prices have been rising sharply in anticipation that the Federal Reserve will engage in additional monetary easing.

With the Fed all but certain to increase its balance sheet by creating additional dollars and purchasing treasuries, the US Dollar has been falling in value, boosting commodity prices.  The details regarding the magnitude and timing should be released in the next FOMC policy statement on November 3rd.

How to get exposure in the Metals

All the rage has been in gold, the ultimate hedge against inflation and the debasing of the US Dollar.  Many affirm that Gold is the true reserve currency of the world.  The drawback to Gold is that the yellow metal has minimal industrial use compared to other commodities that are much more essential to human existence.  Below is a monthly chart on Gold futures showing the huge rally just in the past two years ...

The Gold trade has become very crowded, with hot speculative money pushing up prices in advance of the Fed's easing.  The green arrow shows the latest activity in October.  As you can see, Gold is off its all time highs, eclipsing over $1380/ounce and settling yesterday at around $1325.

You may consider waiting for a pullback before committing fresh money, but Gold has been a winner and, until proven otherwise, it can be added to a portfolio.

GLD is an exchange traded fund that tracks spot gold.  It’s very liquid and trades options actively.

Two other metals that should not be overlooked are Silver and Copper. 

Silver is considered a semi-precious metal that has some of the same valuation characteristics of Gold; however, Silver goes one step further in that it has more functional use as a resource commodity, which gives it a possible long term edge over Gold against price volatility.  The best way to get direct exposure to silver prices is through the i Shares Silver Trust ETF, SLV.  This product is also very liquid and actively traded.

The real pure play in metals, however, would be Copper.  This metal is of great industrial importance, particularly thanks to growing demand from the emerging markets.  Copper appears to be a win/win:  It should do well if the global recovery escalates, as there will be more organic demand for this resource, and prices should also rise if further debasement of the US Dollar occurs from future Fed actions.  You can get Copper exposure through the i Path/Dow Jones exchange traded note, JJC.  Another way to get exposure is through stock equity in copper mining companies such as Freeport-McMoRan (Sym: FCX).

How to get exposure in Energy

The world is addicted to crude oil.  Until alternative energy sources become a viable substitute to fuel global activity, this is the reality for the foreseeable future.

Having exposure directly in Crude Oil or in the Oil Service Sector is vital to a well balanced portfolio.  Active trading has also been attractive, thanks to volatile short term trading ranges.

Crude Oil is a good bet as the global recovery strengthens, as a pickup in demand will put upward pressure on prices.  Also, this commodity usually trades inversely to the US Dollar, so the additional easing by the Fed will prop up prices.

The wild card to having crude oil exposure is the ongoing threat of more instability in the Middle East.  Eventually, Iran will have to be confronted as they become a greater threat in the region as their nuclear capabilities progress.  Any major outbreak in tensions should send oil prices up sharply.

The United States Oil Fund (SYM: USO) is one way to get exposure to West Texas Intermediate Crude futures.  This product is a good alternative to opening up a futures account.

Another way to get exposure to this industry is through the Oil Service sector.  These companies have a direct involvement in getting the oil out of the ground, and they make a ton of money.  Another plus is that this industry was hammered from the Gulf of Mexico oil disaster this past Spring.  Although the industry has since rallied from its lows, most of these companies are still off of their highs.  Any pull back in prices is a definite buy in this sector.  A good diversified way to get exposure is through the Oil Service HOLDRS ETF, Symbol: OIH.

Below is a daily chart on OIH.

How to get exposure in Agriculture

This is the most basic -- and frequently taken for granted -- commodity of them all:  Food and farming.  It’s essential to our existence, and food consumption and supply will be a serious issue in the future as world population growth expands.

This year has been a stark reminder of how sensitive food prices can become.  From the serious droughts in Russia crushing wheat production halting exports, to Corn setting new highs from lower yield production here in the US, food prices are a relevant story.

The soaring prices are not just limited to the grains; you’re seeing soybeans, livestock, coffee, and cotton rally.  The trends are strong, and any pull back would be a good buying opportunity to get exposure in this sector.

Two ETFs to get broad exposure to this space are the Market Vectors Agribusiness ETF, MOO and the PowerShares Agriculture Fund ETF, DBA.

Below is a chart on MOO ...

Commodity exposure needs to be an integral part of any well balanced portfolio.  The US Dollar is trying to rally from its oversold levels, and this is putting pressure on commodity prices.  Consider using this opportunity get long exposure on any pull backs.

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