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Why 2014 Could Be Tough For Commodity Investors


Following the basic rules of supply and demand can yield winning investment strategies -- regardless of the industry.

Of course, this rule holds more weight in the commodities sector than any other.

Falling supply and rising demand can yield robust gains, though this entire asset class has gone the wrong way in 2013. Supply has overwhelmed demand, and the prices for most commodities have been flat to down.

The PowerShares DB Commodity Index ETF (NYSE: DBC), which tracks energy, mining and agricultural commodity prices, is off nearly 10% this year, badly lagging the S&P 500's 25% gain.

In response to falling prices for many commodities, producers have been restraining output, and if the laws of economics apply, then supply should fall below the levels of demand, leading prices to firm up. That process is surely underway in many areas, but unfortunately will take a considerable amount of time to play out. Here's a deeper breakdown of specific commodity trends, and how they will likely fare in 2014.

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Gold And Silver​

When companies decide to invest millions to develop a gold or silver mine, then they better have a long-term focus. It can take years for production at a new mine to begin. And gold and silver producers are now suffering from decisions they made several years ago when prices were much higher. They can't simply change their plans and cut output, and instead must wait for the recent robust spending cycle to run its course.

That likely means supply is unlikely to fall enough to support prices in 2014, and considering that many bullish bets by hedge funds are now being unwound, demand is likely to slump further in 2014 as well.

Still, even with depressed gold and silver prices, opportunities are beginning to re-emerge. Citigroup's Tobias Lefkowich thinks "low-cost companies with a better balance sheet that can continue to grow may outperform." He's partial to Goldcorp (NYSE: GG), and analysts at Barclays agree with him. They consider the stock to be a top pick for 2014, noting that its fully-loaded production costs equate to $888 an ounce, which is roughly 7% below the industry average of $959.

Goldcorp would also sharply benefit if gold prices eventually rebound. The company is boosting output by more than 30% over the next few years, with much of that supply coming online as key mines at other firms start to see rising depletion rates. Net/net, it's OK to be bearish on gold and silver and start to bottom-fish for deep values.

You can read about one StreetAuthority's top gold ideas for 2014 in this recent article.​


Coal And Aluminum​

It's easy to group these two these two commodities together.

Tepid demand has kept prices low for an extended period, and few catalysts exist for an imminent upturn. Long-term, the outlooks diverge. Coal producers periodically make for good short-term trades as they become oversold from already cheap levels, but environmental concerns still look likely to doom this energy source over the long haul.

In contrast, the supply-and-demand equation for aluminum is likely to shift in coming years. As Citigroup's Lefkowich notes, "prices have already dropped significantly and existing assets are facing closure, a sign of a market bottom."

Ford (NYSE: F) will be releasing a new F-150 pickup truck in 2014, utilizing more than a thousand of pounds of aluminum per truck, and other automakers are following suit. It will be interesting to see how the auto industry affects supply and demand.

Shares of Alcoa (NYSE: AA), which have rebounded 20% in the past 10 weeks, could be a harbinger of better days ahead for aluminum producers.​


Shares of steelmakers have been surging lately, on signs that demand and pricing are firming. But caution is warranted, as it's best to own these stocks at a time of maximum pessimism. Back in April, I took note of the steady plunge in of AK Steel (NYSE: AKS), yet now that shares have doubled, it's logical to wait for the next bout of pessimism to re-emerge.

If you are bullish on steel, then few firms are as highly-leveraged to a rebound as ArcelorMittal (NYSE: MT). The company's debt-laden balance sheet has been a major concern, but firmer steel prices would change that view. If you see shares move above $20, then the debt concerns will likely have lifted and investors will focus on just how much money this steel giant can make in an upturn.


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Bleak Oil?​

A few months ago, I predicted that "our global need for oil is about to peak and eventually decline." It's an admittedly a minority viewpoint now, but rapid efficiency gains are already having a major effect on oil consumption in developed economies, and emerging market economies are likely to follow suit.

Meanwhile, the supply of oil in the United States, Iraq, off the coast of Africa, Brazil and elsewhere, continues to rise. Even places like Russia and Mexico, which have been neglecting their oil production infrastructure, are making plans to reinvigorate output. 

It's the supply part of the equation that leads analysts at Deutsche Bank AG (NYSE: DB) to predict that WTI (West Texas Intermediate) crude oil prices will fall from a current $99 a barrel to $85 by next summer and $80 by 2016.

If that scenario plays out, the world's highest-cost producers will run into trouble. Indeed, the major oil firms such as ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) have already begun allocating more capital to share buybacks and dividends than exploration. They are having a hard time finding new areas to profitably drill for oil, and that's with current prices still near $100 per barrel.

Deutsche Bank's analysts suggest investors focus elsewhere in 2014: "While we had preferred E&P (exploration and production) companies with U.S. production opportunities over most of the energy majors, we think that is now largely priced into stocks."​



If oil prices come under pressure, and natural gas prices remain at current levels, then the profit backdrop for chemical companies will only strengthen.

A range of major global chemical companies are setting up shop in the United States to produce chemicals. A recent article in The Wall Street Journal notes that German chemical giant BASF is "shifting more of its production and research investment to the U.S. to ride the nation's economic recovery and shale-gas boom." The Materials Select Sector SPDR ETF (NYSE: XLB) appears to be the most direct way to profit from the trend.​


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Agriculture ​

It's unclear why farm prices tend to swing so wildly these days.

For example, surging corn and soybean prices in 2012 have been met with sharp pullbacks in 2013. You would think the entire industry would prefer to work with pricing mechanisms (such as hedging) that smooth out the booms and busts. 

In a separate column, I'll be looking at agricultural commodities in greater depth, but it's pretty clear this sector will yield fertile opportunities -- on the upside and downside -- in 2014 as well.

Risks to Consider: Many commodities are economically sensitive, and if the U.S. and European economies fail to strengthen in 2014, then many commodities could see even deeper price slumps.

Action to Take --> It's unwise to paint commodities with a broad brush. The supply and demand dynamics are quite different in each category, and looking at how these two factors are trending can help determine the winners and losers of 2014.  

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