Hard Times Investing

Hard Times Investing: Commodities Offer Slim Pickins

Jessica Rao,|Special to CNBC
Key Points

Wheat, corn and soybeans best bets.

Year-long copper rally may be nearing.

Global economy keeps crude oil range-bound. 

When it comes to commodities these days, if you can't eat it, don't buy it.

You won't find much hot money or many momentum traders in commodities. Even recent stars aren't what they used to be. The gold rush has cooled and crude oil is at the mercy of a choppy global economic rebound. If you're looking for action, try grains, or other agricultural proucts, but even that may be iffy. It all depends on the weather.

Here's the outlook for the major commodities groups.

Grains: Wheat Stands Out

In recent years, the Black Sea region, including Russia and the Ukraine, has become a leading supplier of cheap wheat. Now the region is facing one of the worst droughts in history. Couple that with extremely dry weather in Europe and flooding in Canada, and the world’s supply of wheat is way down.

“Nobody really knows yet just how bad it is, but there’s no doubt in my mind that we have seen the lows in our wheat market,” says Bill Gary, president of Commodity Information Systems Inc.

Traders and investors have also seen the end user enter the market aggressively just to get their needs covered.

“If you are Nabisco or Kraft or somebody that needs wheat, your job is to have it and you don’t really care if you’re paying $5 or $7 [a bushel], you are going to make those crackers every month,” says Justin Kelly, President of Ehedger.

Adam Klopfenstein, Senior Market Strategist at Lind-Waldock, a division of MF Global agrees. “Wheat is going to out perform a lot of other assets as we finish 2010,” he says.

Corn, barley and soybeans have rallied in response to wheat, but if the weather cooperates, both crops are expected to yield record harvests this year, which is not bullish for pricing, says Kelly.

Going forward, however, grains may be the commodity family to watch.

“My long-term favorite is people food,” says Gary, “It will become even more important that crude oil.”

Expanding incomes--and growing appetites—in Asia will drive consumption and thus prices.

Metals: Copper Vs. Gold

Weaker-than-expected US growth, the sluggish residential construction market and concerns about a slowdown in the Chinese economy will probably put a damper on the year-long rally in copper prices. Prices rose 12 percent in July--the biggest one-month gain in a year--and are up 22 percent in the past 12 months.

Supply, more so than demand, has been the market driver, with prices on the futures market touching $3.40 a pound

“Looking out towards the end of 2010, it is going to be very tough to see sustainable trade in copper above $3.50 [a pound],” says Klopfenstein.

Though there has been a lot volatility lately, the price of gold may move higher through the end of the year because it is viewed as an inflation hedge and a safe bet during uncertain times.

Klopfenstein says gold could approach $1225 to $1250 an ounce by the end of the year, but that's still below its April high of $1266.

Though silver may follow gold from time to time, analysts say it's likely to be stuck in a trading range.

:  Gas Above Crude

Crude will likely be stuck in a broad-based trading range through the end of 2010. Record-high inventory levels and a weak economy will put downward pressure on prices.

Of course, there's always geopolitics to undermine even the best forecast. "We may see rising anxiety about Iran and the market may start to be more concerned about the risk of military confrontation or a disruption in Iranian exports," says Antoine Halff, Head of Commodities Research, at Newedge LLC.

Whenever you have someone who takes a massive amount of supply out of the market, the situation can cause people to scramble,” Klopfenstei
Adam Klopfenstein

Another wild card is oil as a weak dollar hedge, as was the case for much of 2008.

Natural gas is the better bet for building a long bullish position due to its low relative price, says Haff. There may also be more pressure on the political side to convert more facilities to natural gas because it is a cleaner-burning fuel and US supplies are ample. Potentially strong weather-related demand is also positive for a gas market that has been weak.

Miscellaneous: Hot Cocoa

There’s been a lot of talk recently about the cocoa market because Armajaro, a London-based hedge fund, bought roughly 7 percent of the global supply and sent the price skyrocketing to levels not seen since 1977.

“Whenever you have someone who takes a massive amount of supply out of the market, the situation can cause people to scramble,” says Klopfenstein.

End users may also not feel comfortable waiting to see if prices go lower. Furthermore, if the Ivory Coast's next harvest disappoints, cocoa has the potential to rally into the end of the year.

In general, commodities’ prices are affected by the supply demand dynamic, the world economy, and more recently, the strength of dollar. With the future spotlight on the agricultural sector, we may be getting back to basics and weather may be the most telling indicator of future markets. Meteorologists may be worth their weight in gold.