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Commodities - The Bullish Case

A recovering world economy may just be the wind beneath the wings to lift commodities, last year’s laggard, to new heights. To some investors they appear too cheap to resist buying.

This is a cyclical story. Stocks had their run in recent times, with last year a blowout too high to be repeated. Stands to reason that the seesaw should go the other way soon: While the Standard & Poor’s 500 soared in 2013 by nearly 30%, the Dow Jones-UBS Commodity Index dipped 9.6%.

Precious metal investors had the worst of the pain, particularly gold (down 28%), as they endured their worse year in almost two decades. Agriculture investors also suffered last year as demand from Asia, and especially China, as well as the recession in Europe and a little belt-tightening by U.S. consumers in left few places to hide.

This marked a reversal of a long-term trend, which surging worldwide demand fueled. To put this decline in commodities in perspective, let’s look back to the first decade of this century. From the end of 1999 to the end of 2009, there were awesome increases in the broad commodities market.

Gold advanced 278%, silver gained 209% and king copper rose 288%. Crude oil rose 210%. And how good were agriculture markets? Well, the two biggest gainers during this period had stunning run-ups: sugar (340%) and cocoa (293%). In fact, 16 commodities more than doubled for the decade with only one commodity, palladium, registering a loss.

Thus the recent fall in commodities could simply be a hiccup in a long upward trend. All great runs come to an end. Massive purchasing by China was a big reason for the decade-long commodity boom. So was the real estate mania in the U.S, Spain and a few other places. When these stimuli backed off, so did commodities.

Some market watchers speculate that 2014 may be a year to get back into some commodities, which they think are very much oversold. Recently in an interview onCNBC, James Paulsen of Wells Capital Management said he expects the broad commodities asset class to outperform stocks and bonds in 2014. Commodities “got crushed over the last year and a half,” he said. “So I think there's good value here for the first time." His reasoning: Global economic growth will boost demand for commodities again.

Certainly, the long-delayed worldwide economic rebound appears much more likely. TheWorld Bank forecasts a modest global increase of 3.2% this year, compared to 2.4% in 2013. Even Japan, mired in a two decade-long slump, has good prospects, thanks to Tokyo’s fiscal and monetary pushes.

Developing economies will grow 5.3%, down from the torrid double-digit numbers of years past but better than before, the bank predicts. India faces inflation and currency problems, and China has invested too much too unwisely, but they are poised to surmount their woes.

The cycle in investor sentiment also has a role in commodities’ recovering, other observers say. They simply think that, after such a hot year in stocks and an almost 2% decline in the bond market, commodities and stocks will normalize as investors rotate from the hot asset class to the cold asset class. In the same CNBC interview Anuraag Shah, the chief investment officer of Tusker Capital, a commodities hedge fund, advocated "But we're not saying that commodities will rally – just that stocks and commodities will equalize more, because we're bearish on stocks."

Indeed, there’s a strong argument that equities flew so high because of the Federal Reserve’s massive bond buying, which held bonds’ yields down and made stocks seem more attractive. But now the Fed plans to taper down its bond program, known as quantitative easing. Odds are that the stock market eventually will throw a taper-tantrum and fall hard. In Shah’s words "It hasn't happened yet, but it's going to happen."

When this does occur, commodities will look good. If inflation kicks up with economic expansion, commodities historically do well.

Nobody, of course, can predict the timing with certainty. Where there is great risk there can be great reward, yet one can run out of money waiting for the reward.

Take a step back from the short-term price action in commodities and think longer-term. The U.S. just tapped into a domestic mother lode of natural gas and oil? How will they get this new supply to market and which markets is the new supply heading to? How much copper and iron and tin will developing economies need as they want more cars, refrigerators, indoor plumbing and ovens? Is there enough clean drinking water for 7.2 billion people and counting over the coming years?

Sounds like commodities have the wind at their back, or will before too long.