2012 will be a difficult year for commodities
By
MoneyWeek Editor
John Stepek Dec 22, 2011
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The boom in commodity prices over the last decade has been bad news for Britain's infrastructure.
As China builds up its cities, the rise in metals prices has tempted thieves in the West to start tearing down our own.
Everything from church roofs to copper railway cabling has been targeted. Theft from the railways in London rose 70% last year. Energy firms report 700 thefts a week from substations and pylons, reports the London Evening Standard. Six people died last year trying to steal live cables.
The problem has got so bad that the government is now planning to force scrap merchants to make more stringent background checks when they buy metal. Cash transactions may also be banned.
Why am I telling you this? Because these new rules are a warning sign for investors. They're saying the recent slide in commodity prices has further to go…
Why government activity is a lagging indicator
Metals theft is getting a lot of press, but it's been a problem for a long time.
In economic terms, it's straightforward. As metal prices have shot up, so has the incentive to steal. Objects once deemed of little value, and therefore not worth protecting from theft, are now much more desirable. Thieves have been given a relatively low-risk, high-return opportunity.
If you wanted to pass a law to make it harder for thieves to offload their stolen goods, it would have been best to do it as soon as it became clear that metal prices would keep rising.
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But that's not the way governments work. They are slow moving and reactive. So an issue has to have a lot of momentum behind it before it can be addressed.
Fund managers are fond of the quote: "If it's in the press, it's in the price". In other words, if a financial story is hitting the headlines, then its implications are already fully reflected in the market.
Well, governments are even further behind the market than journalists are. Because a lot of the time, politicians don't react until after a story is hitting the headlines. So usually, if you see the government trying to close a stable door, it's safe to assume that the horse bolted long ago.
So if they are trying to take action to address one of the unpleasant side effects of the surge in commodity prices, then my gut feeling is that prices have further to fall.
China's slump is bad news for commodity prices
That's why the news that the government now wants to ban scrap merchants from doing cash deals bodes ill for commodity prices. I'm sure the rule is sensible enough. But they've missed the boat.
Thieves will have less incentive to steal next year, because commodity prices have already peaked. Copper hit its high for the year in February, at more than $10,000 per ton. It's now trading around the $7,500 mark, according to London Metal Exchange data.
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And I doubt that we've seen the bottom yet. China's property bubble seems to have well and truly popped. In short, that suggests that Chinese developers won't be building half as many new homes. And as financing new infrastructure projects through land sales becomes more difficult, there will be less expansion on that front too. Meanwhile, Europe seems certain to end up in recession next year (if it isn't already).
In the longer run, I don't think we've seen the end of the 'supercycle' necessarily. The one thing that would take everyone by surprise in the next few years would be a strong recovery in the US. Amid the focus on China, it's easy to forget that the US construction industry has been decimated. If that was to make a comeback, it could help bolster demand for commodities, even if China is in trouble.
But for now, I'd be betting on a stronger dollar, and generally weaker commodity prices. How do you play that?
Avoid miners, short the Aussie
I'd avoid the base metal miners. They've had a pretty miserable year this year, but if a full-blown market panic over China develops, they will fall further.
And I still think that shorting the Aussie dollar is a good bet. It's fallen by 1% or so overall against the US dollar this year to date. But if the housing bubble over there pops, Australia's economy could be in for a lot more pain than anyone expects.
If you don't fancy dabbling in the currency markets, then you can play the recovering US dollar by investing in US blue chip stocks, or FTSE 100 stocks with heavy exposure to dollar earnings. I mentioned a few options in a recent Money Morning – you can read the piece here.
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