Soaring commodities prices raise bubble fears

Advisers uncertain over the future direction of sky-high commodities prices have impressive company — commodities experts themselves. Some say the slowing economy will put an end to price increases, while others contend that growing demand and the falling dollar will fuel further increases for many years. One prominent commodity skeptic, Tobias Levkovich, chief U.S. equity strategist at Citigroup Investment Research in New York, recently called commodity prices "bubblicious." In a report late last month, he noted that during recessions, the prices of industrial commodities have fallen by an average of 19%. These price declines occur even during inflationary periods, Mr. Levkovich wrote. In the 1970s, commodities prices roughly tripled over a 10-year period, he wrote last month. But in the current phase, prices have "surged almost [250%] in about half the number of years, lifting the risk profile as leveraged speculative money has come in." Some of the recent rise, however, is due to the falling dollar, Mr. Levkovich said. Jim Rogers, Singapore-based international investor, author and developer of the Rogers International Commodities Index, said the bull run in commodities began in January 1999. So are we about halfway through the commodities cycle?
"Who knows with this one?" Mr. Rogers said. "But the only bull market I know of right now is in commodities. The markets may seem to be at their peak, but "if I told you in 1990 to buy stocks, you would have said I was nuts [to buy] after the market had tripled in eight years," Mr. Rogers said. "And we know what happened then." Stock cycles tend to coincide with commodities cycles, only in reverse, Mr. Rogers said. Advisers are of two minds as well. Not long ago, many advisers rejected the idea of adding commodities to a portfolio, but now they're reconsidering, said Brad Zigler, Santa Rosa, Calif.-based managing editor of hardassetsinvestor.com of New York. And yet among advisers, "universally, there's been growing interest [in commodities], especially in the last six months or so," Mr. Zigler said. The growing popularity of commodities-linked investment products is a warning sign that the markets are near a top, said Richard Ferri, founder and chief executive of Portfolio Solutions LLC, a Troy, Mich., firm that manages about $800 million. "It's jumping on the bandwagon, and that's the sign of a speculative bubble," he said. "The problem is going to be that everybody will try to get out [of commodities] at the same time." The commodities bubble has already popped, said Manny Weintraub, founder of Integre Advisors LLC, a New York firm with $187 million under management. The recent run-ups in food prices and the resulting riots in several countries signaled a "ringing of the bell" at the peak, he said. "Food is primal," Mr. Weintraub said. "Without food, there's no security." Food price inflation will force central banks to raise interest rates, ending the commodities boom, much of which has been driven by momentum from investors, Mr. Weintraub said. Based on their long-term trends, commodities as a group are now about 20% overvalued, said Michael Jones, chairman and chief investment officer of Riverfront Investment Group LLC in Richmond, Va. "But is that a bubble?" Mr. Jones asked. Since commodities have become 100% overvalued on numerous occasions in the past, he said, Riverfront is hesitant to change its 3% allocation to commodities-linked exchange traded funds. "One of worst mistakes you can make is jumping off too early," Mr. Jones said.

STILL BELIEVING

True believers argue that long-term up cycles for hard assets historically run for 15- to 23-year periods. The latest upturn in the commodities cycle began only five to seven years ago, they say. Mr. Zigler said the bottom came in 2000, with a sustained up move beginning in late 2002. "Until the [cheap-dollar] policies that gave rise to inflation pressures abate, this [commodities] cycle has legs," as commodities are denominated in dollars, he said. Current price levels aside, Mr. Zigler said, commodities futures and hard assets have become an accepted part of a diversified portfolio. He credits New Haven, Conn.-based Yale University's endowment fund with popularizing the use of such investments. The fund now has about a quarter of its portfolio in real assets, including futures — down somewhat from last year, Mr. Zigler said. "About a third of the [Yale] operating budget is funded by its endowment," he said, which means that the endowment "is analogous to [an individual investor's] retirement fund, where you have to pay out some [of the assets] and still grow it." By using commodities-linked ETFs, retail advisers can approximate that strategy, Mr. Zigler said. Mr. Ferri, however, faults many of the newly minted commodities indexes that advisers may be tempted to use. Newer indexes employ strategies that produce good back-tested performance, which is critical for licensing purposes, he said, but future performance is doubtful. Mr. Rogers said his index, which has been around since 1998, has outperformed other commodities indexes, which he said are too heavily weighted with energy. Regardless of how an index is constituted, investors don't need them, Mr. Ferri said. Most investors already have significant exposure to commodities simply by holding a diversified stock portfolio, he said, because commodities stocks and materials stocks make up about 17% of U.S. equity markets. E-mail Dan Jamieson at djamieson@investmentnews.com.