The End Of The Road?

All things commodities have come way down in the last few weeks.

PowerShares DB Commodity Index Fund (DBC) is down 17% from its July 2 closing high.

iShares Comex Gold Trust (IAU) is down 10.4% from its recent July 15 closing high.

iShares Brazil (EWZ) is down 25% from its high a couple of months ago.

Unites States Oil (USO) is down 18.6% since July11.

You get the idea.

So it is over? As one reader asked, are we done worrying about inflation? What will become of equities and bonds as a result of this? What about the dollar?

Before we worry about how meaningful this is or isn't the very recent puke down in the related areas is exactly why I preach moderation with exposure to these themes. I have talked repeatedly about 5% or so being, IMO, a good number for commodity exposure. If you put 5% into some commodity proxy and it doubled, that would be enough to add real value to a portfolio. On the other side of the coin a 5% weight in something that cuts in half (I realize that is not where we are) cannot set you back for a year or two and reasonably would not cause undue angst.

I have been as bullish and early as almost anyone but have stressed moderation throughout. The entire resources theme has offered many chances to reduce exposure as prices often got ahead of reality or sentiment just got too carried away (here is one example I wrote about in May).

In the last couple of months, one for a greenfaucet podcast and one for SmartMoney magazine (this was in late June when I was in Boston and have no idea if the magazine actually used my quotes or not) I gave two interviews where we touched on oil. In those interviews I said I could see oil headed to $120-$125 (I may have said $115 but you get the idea).

So if I thought $120 was possible I probably shouldn't be shocked that we are here. Can we go lower might be one question on people's mind but the better question is if it goes down will it stay down? In late 2006/early 2007 oil fell from the mid $60s down to about $50 in what seemed like ten minutes which was a bigger drop than the current decline. The current decline is smaller still when you consider that the drop to $50 started from close to $80 a few months earlier.

Last summer EWZ fell 22% in a month. In the spring of 2006 EWZ fell 24% in about a month. And it had a 22% decline in the spring of 2004.

Many people talked about how over extended all the resource names were and the reaction seemed to universally be oh yeah, we agree they're over done and should pullback. So now they pullback and the bubble has popped? Really?

The fundamental story has not changed in the last couple of weeks. The places using resources are still using them. The long term trajectories for demand growth have not changed. These trajectories never changed in such a way that justified oil going from $88 or whatever up to one forty whatever--that's why people used to say they were over extended.

I don't think this correction or end of the story, whatever it turns out to be, means the end of Fed's vigilance. It might relieve some immediate concerns about inflation however. I would note that I think the asset deflation issues trump the issues with the prices that are rising.

The dollar has had plenty of snap back rallies like the current one in the last few years so I am not sure why this would be different. As far as interest rates go, they have to rise (not talking about the Fed Funds rate) for several reasons but long time readers will know I would have expected this to have started quite awhile ago so I probably don't have a good feel for this aspect of it.

As for equities this is still, IMO, a bear market rally, aka a feel good rally. A couple of weeks ago I said in a video that 1310 might be a place for a rally to go. But in the context of this being a feel good rally in a bear market, that means that I still think normal bear market. Normal means 30% from the peak which works out to SPX 1095. Regardless of whether that is right or wrong I would start to reequitize in a meaningful way when the market takes back its 200 DMA as that has been my plan since long before the bear market started.

More important than any of the above is that if you took a moderate approach to this than you have much less riding on being correct. With a moderate approach you have benefited from the multi year rally without being piggish and this decline hasn't killed you. For that matter none of the previous commodity corrections killed you either.

The reason I am so preachy about the moderation of these things is that the idea of waiting until there is a problem, as depicted on TV, creates unnecessary anguish. Obviously no one can be out in front of everything but pre-planning and discipline can go a long way toward smoothing out the ride.