Since 2009, most commodities have been on a fairly strong, and sustained, run. But in recent months, that trend has shown signs of reversing. Some prominent fund managers have called for the end of the great commodities “super cycle” — if that’s truly the case, how should investors position themselves?
The commodities super cycle
Along with equities, commodity prices largely plummeted during the financial crisis, bottoming early in 2009. Then, from March 2009 until recently, both commodities and equities moved in tandem — that is to say, much higher.
But something changed recently. Although equities have continued to rally, commodities have broken down, or traded in a fairly tight range. While this could just be a temporary reset, some — like former hedge fund manager Stanley Druckenmiller — think the commodity bull run has finally come to an end.
Direct plays on commodities
Obviously, the easiest way to play a breakdown in commodity prices is to trade the commodities themselves, or companies with heavy exposure to them.
Gold has received a lot of attention over the last few years. After peaking near $2,000, the yellow metal has slowly pulled back. Now trading near $1,380, gold is roughly 30% off from its 2011 high.
SPDR Gold Trust (ETF) (NYSEMKT:GLD) is a direct play on gold. Shares of SPDR Gold Trust (ETF) (NYSEMKT:GLD) are down about 25% from September 2011.
But things have been worse for gold miners — often seen as a leveraged play on gold. While the miners can easily outperform the metal on the way up, the move down can be equally as grim. Shares of Barrick Gold Corporation (USA) (NYSE:ABX), for example, are down more than 60% from August 2011.
Barrick Gold Corporation (USA) (NYSE:ABX) has loaded itself up with debt in recent years — about $14 billion in total. It costs the company roughly $900 to produce one ounce of gold. Consequently, although it trades with a forward price-to-earnings ratio of around 5.6 (far below the broader market), if gold prices continue to break down, Barrick Gold Corporation (USA) (NYSE:ABX) shares should continue to drop.
This is, of course, just one of the better known gold miners. In general, miners and commodity producing companies in other industries (oil, agriculture, etc.) should see similar share price drops if the commodity super cycle is truly over.
Commodity-dependent economies
Like commodity-producing companies, some countries have economies that are largely dependent on the market for commodities. In particular, both Canada and Australia are massively exposed.
At the Ira Sohn investment conference earlier this month, Druckenmiller argued for shorting the Australian dollar. Australia’s economy has been fairly strong in recent years, mostly because about one-fifth of its economy is dependent on mining.
With the prices of Australia’s mining-related exports falling, demand for the country’s currency should likewise decline. Although investors could play the country’s currency directly, there are ETFs that allow for investors to basically trade the currency without getting into the forex market directly.
Canada’s housing market
Like Australia, Canada should struggle in an environment of falling commodities. In addition to mining, Canada’s economy has tremendous exposure to other commodities such as oil and lumber.
Although fund manager Steve Eisman is bullish on US housing, he’s notably bearish on the Canadian housing market. In particular, he believes Canadian banks will get hit hard when the Canadian housing market cracks.
Since March 2009, shares of Canadian mega bank Toronto-Dominion Bank (USA) (NYSE:TD) are up nearly 180%. That’s roughly double the performance of Goldman Sachs Group, Inc. (NYSE:GS) over the same period of time.
On a recent earnings call, Toronto-Dominion Bank (USA) (NYSE:TD) admitted that the Canadian housing market was “cooling.” If Canada soon faces its own housing crisis, the Canadian financials — like Toronto-Dominion Bank (USA) (NYSE:TD) — should be expected to perform poorly.
The end of the commodities super cycle?
Commodities have been rewarding investors in recent years, but have disappointed as of late. If, as some have alleged, the great commodity super cycle is finally over, investors should position themselves appropriately.
Obviously, reducing direct exposure to commodities makes sense, but secondary plays like commodity producing companies and countries should also be expected to perform poorly.
The article How to Play the End of the Commodity Super Cycle originally appeared on Fool.com is written by Salvatore “Sam” Mattera.
Joe Kurtz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Salvatore “Sam” is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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