Commodities appear to be in freefall with lots of catalysts being thrown around: a stronger dollar index, changes in the global macro-economic outlook, core PCE inflation in the U.S still slowing, and the Fed openly contemplating tapering its asset-purchase program. All of these factors are likely to put commodities under further selling pressure. Naturally, investors can still profit from declining commodities by shorting companies that have high exposure to them or by purchasing ETFs with an inverse exposure to commodities.
The-worst performing commodity
Gold recently traded below $1,200 an ounce for the first time since 2010. Investors are quick to point out that after steadily moving higher for 10 years, the upward trend has broken over recent months, shattering the confidence of those who thought that gold would continue rising to new highs for years to come. I believe that the fundamental justifications for holding gold products (physical gold, ETFs, gold mining companies etc) have substantially diminished.
Going back a few years, the main argument toward accumulating gold was that the Fed’s QE would lead to a substantial increase in inflation with the term hyperinflation also thrown around. Reality is, five years after the Fed commenced its QE program, global inflation continues to fall, with core US PCE deflator inflation falling to the lowest level seen since the series was first calculated in the 1960s.
Bad news for the gold miners
Gold miners have been in panic mode for a few months as many companies have taken on large amounts of debt to finance big new projects. It made sense at the time: gold prices has been flying for the past few years combined with low interest rates, which made taking on debt a more attractive option rather than equity. In 2005, the cost of mining an ounce of gold was $280, while this number has risen to $775 in 2012.
There is no surprise that the Market Vectors Gold Miners ETF (NYSEMKT:GDX) lost around half its value in 2012, with more downside to be seen. So long as gold prices continue plunging, miners will be under tremendous pressure as it is the price of gold doesn’t cover the overall costs of many miners. Bottom line, with enormous fixed operating costs and declining gold prices, a mining company’s cash flow can end up swinging more dramatically than gold itself.
Investors can profit from the gold miners demise by purchasing the Direxion Daily Gold Miners Bear 3X ETF. The ETF is designed to provide investors with a daily return that is equal to three times the inverse of the Gold Miners index. The ETF is amongst one of the best performing in the entire market, up (at the time of this writing) over $80 per share. Leveraged ETFs such as this provide investors with a great opportunity take advantage of short- to medium-term negative trends that I have highlighted.
It is also important to note that due to the huge volatility in gold prices we have seen recently, coupled with the fact that this ETF is triple leveraged, the fund is obviously designed for an investor with a higher risk tolerance. The ETF can see 20% daily swings in either direction.
No positives for this company involved in copper and gold
Copper has fallen around 34% since it’s all-time high back in February 2011 on the heals of a slowing global economic growth. Copper has traded at levels that were at least double the marginal cost of production as countries like China were left with supply deficits. This was all great news for Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) back in 2012. Needless to say a lot has changed.
With copper-price forecasts being cut at virtually every research firm, this does not translate well for the company that owns the world’s third-largest copper mine. This mine was also the site of a massive accident that resulted in 28 casualties. Operations at this mine (named Grasberg) in Indonesia remain suspended and the company’s estimated daily production loss is 1 million pounds of copper and 1,000 ounces of gold per day. Gold also makes up approximately 15% of the company’s portfolio, and as fate would have it the world’s largest gold mine also happens to be the very same Grasberg mine.
Investors will be closely watching the company’s second-quarter earnings, which are due in late July.
Aluminum: All pain and no gain
An often forgotten commodity, aluminum, has also seen it’s price come under extreme pressure. As with other major commodities, the second half of 2013 will see an ebbing of the largely seasonal growth in China, which is responsible for about 46% of global aluminum use. A slowing China will weigh heavily on the overall balance, and can lead to excess supply on the global stages.
Investors should short the most heavily shorted Dow component
The world’s third-largest aluminum producer and Dow Jones industrial average component, Alcoa Inc (NYSE:AA), has hinted at the possibility of further reductions in supply at its higher-cost plants. The company currently has 568 kt/y offline, about 13% of its global capacity, and has stated it will review the potential for an additional 460 kt/y of cuts over the next 15 months. Shares of Alcoa Inc (NYSE:AA) are trading not far off from historical lows, and the stock remains the most heavily shorted on the Dow. Investors are confident that so long as aluminum prices continue declining, shareholders of Alcoa Inc (NYSE:AA) will feel pain, while shorts will rake in profits.
Final remarks
The commodity bear market is official and as it stands now looks like it will last for a while. Investors who think that commodities have bottomed out are trying to catch a falling knife and will only hurt themselves. The writing is on the wall: with global growth remaining subdued over the second half of 2013, and Chinese activity slowing, the commodity complex is likely to remain under pressure, at least for the second half of 2013.
The article How to Profit From a Continued Commodities Slump originally appeared on Fool.com.
Jayson Derrick has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Jayson 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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