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How to Invest in Bottoming Commodities

Debbie Carlson

After falling to multi-year and in some cases, multi-decade lows, it appears that commodity markets might be bottoming.

Barclays says the low the Bloomberg Commodity index put in during January's selloff matched the all-time lows last hit in 1999, and since then the index has risen. Investor interest is back in the commodity sector as assets under management for the precious metals, base metals, energy and agriculture markets are rising so far for 2016. That's lifted values, with prices for commodities as disparate as crude oil, iron ore, gasoline, soybeans, coffee and gold all up for the year, too.

There's a sense among commodity-market watchers that natural resource prices have put in a bottom, but the sharp rally has made valuations pricey for the time being.

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For investors wanting to add natural resources to their portfolio, market watchers say buyers should do their homework and wait for price pullbacks to pick up either commodities or commodity-related companies.

Creating a floor, but maybe hitting a ceiling. Commodities and financial markets in general are finding support by a change in investor's appetite for risk and an upturn in Chinese activity, Barclays says.

"We believe that the price lows for key commodities such as oil and U.S. natural gas have now passed. A rewind of 2015 -- a rally followed by an even steeper price fall -- is unlikely, but the commodity resurgence is likely to prove limited," the firm says in a research note.

Indicators like the Baltic Dry Freight index, which measures shipping of bulk commodities like coal, iron ore and grains around the world, rose sharply, which is another positive sign for commodities, says Mike Ciccarelli, commodity and stock trader at Chicago-based Briefing.com.

However, he says, the severity of the rally, with crude oil prices nearly doubled from their 2016 lows, suggests prices have come too far, too fast. So right now he's waiting for the current froth to subside.

The reason the current commodities rally seems rich is that the supply of many commodities is still burdensome, says Rob Haworth, Seattle-based senior investment strategist at U.S. Bank Wealth Management. U.S. Bank agrees commodities are bottoming, but they're underweight the sector for the time being.

"The problem is there's not much catalyst left to drive you higher. And so for us, we're looking in the near-term at a range-bound market that has to deal with a couple of headwinds before you can get higher prices," he says.

Oil production by the OPEC is still growing, he says. And while U.S. oil production is down, the more prices rise, the more likely U.S. producers may restart mothballed rigs, adding to the glut.

Supplies of industrial metals like copper are also lofty, he adds, noting that many mines remain open.

In the agriculture market, weather-related fears and a slow planting season has lifted corn and soybean prices. But as Haworth says, "you have lot of summer left in front of us; we haven't even started it yet. It's a market that remains really quite well supplied."

How to play. The current price run may be getting a bit ripe, but the longer-term picture may improve as end-users work through supply. Barclays says in the short-term it's bearish on oil, but is turning more bullish in the second half of 2016.

Alan Bush, senior financial economist at ADM Investor Services in Chicago, is positive on commodities, especially industrial commodities.

"I believe all the industrial commodities have bottomed, so have precious metals. The reason why I think that is that China has bottomed. A year ago China embarked on a stimulus program and whenever central banks do this it takes about a year. They ramped up their policy initiatives and now we're starting to see the effects of that," Bush says.

Bush says he sees value in the sector now for investors.

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"We're telling our clients to buy industrial commodities. We're telling them to buy them on breaks. That's energy, copper, platinum, palladium. Plus the precious metals gold and silver," he says.

There are futures markets for all of those commodities, but for retail investors, buying exchange-traded funds may be easier. The biggest individual commodity ETFs are United States Oil Fund (USO), ETFS Physical Platinum (PPLT), ETFS Physical Palladium (PALL), SPDR Gold Shares (GLD) and iShares Silver Trust (SLV).

Haworth says for investors interested in oil, he sees more opportunity in the credit side of the sector in the high-yield markets versus equities. Stocks are too pricey now.

Ciccarelli says for investors with longer-term views on commodities, he likes a few companies that are worth considering on a price pullback.

BHP Billiton (BHP) is one of his top picks. The firm is often considered a coal stock, but Ciccarelli says that they own a number of commodity mines such as copper, iron, gold, and coal mines, and the firm has proved oil reserves.

Potash Corp. (POT) the world's largest fertilizer company is another top pick, he says, as fertilizer is a key input for farmers.

His final pick is Pioneer Natural Resources (PXD), which produces both crude oil and natural gas.

One commodity that's become a bit too rich is gold, Haworth notes. The yellow metal is on such a huge run, now near its highest level since January 2015, based on concerns over global economic issues and the European Central Bank and Bank of Japan's move to negative interest rates. The Federal Reserve being less aggressive in hiking interest rates also helped.

But that's likely the extent of gold's gains for now.

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"The Fed eventually will lift interest rates, and that's a headwind to gold prices. ... Without more negative interest rate policies there's not as much reason to demand gold," he says.

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