Mad Money

Cramer: Will the commodity rally run out of gas?

Reality check on commodities: Cramer

The recent rally of commodities has been absolutely breathtaking to Jim Cramer. But he does worry that it could be too good to be true.

"You have to go back to 2008 to see a commodity rally like this one," the "Mad Money" host said. (Tweet this)

As a simple review, commodities rally for two reasons: short supply, or excess demand. It is possible to have one, or both. Either of these options can send the price of the commodity, and companies that exploit them, higher.

Cramer reflected back to 2008 because that was when China's growth started to accelerate, and it created more demand that could not be met by commodity suppliers. That led to price increases in everything. Every material from to coal, to iron ore to zing shot up in price.

In response, producers realized that they had to spend a fortune and ramp up to meet China's demand. That meant that huge projects were created to build gigantic facilities from scratch.

"Almost every executive in these industries bought into the notion that China would grow into the skies," Cramer said.

Gas running out on commodities?

They can only run so far without a turn in demand
Jim Cramer
Noah Berger | Bloomberg | Getty Images

Of course, nothing can be built overnight. So as soon as these projects were up and running or too late to cancel, China's growth rate slowed. The result has been a massive glut in almost every metal and commodity liquid out there — and there is a shortage of space to store the stuff.

That means price cuts to the point where marginal producers have been forced to go under, and losses have built up for iron, copper, zinc, lead, nickel and steel.

In Cramer's perspective, some of these desperate industry executives are finally figuring out that the demand won't come back. Oil exploration has tapered back, copper mining has peaked and coal has cratered.

This is exactly how to get to a commodity bottom, and how the companies make their stocks rally. The production cuts are the reason for the oil rally, and companies like Petrobras and Glencore have become less of a danger zone.

Now that supply has been addressed, what about demand?

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Alcoa's shortfall on Thursday evening was an indicator to Cramer about a company that closes all of its aluminum plants. If you don't have demand, it will be a short-lived rally.

"I'm a believer in Alcoa and I think it's a terrific long-term buy pending the breakup into two companies…but the rest of these stocks? They can only run so far without a turn in demand," Cramer said. (Tweet this)

In order for this commodity rally to continue, Cramer thinks there must be a pickup in demand. Otherwise, investors will need to ring the register on most of these stocks. The companies will disappoint, unless China comes back and Europe gets stronger.

These are the keys to the next leg up, or leg down, in commodity stocks.

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