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Commodities: No Relief

Commodities tend to run in long cycles. The huge run-up in their prices, which peaked in 2011, has now degenerated into a rout. People who think that this situation will stabilize and turn around anytime soon are kidding themselves.China’s pell-mell growth was the stimulus for the so-called commodity super-cycle, which began around 2002. But the huge nation’s expansion couldn’t go on forever at a double-digit clip. China’s deceleration to a 7% rate, while pretty good by Western standards (the U.S. grows at a 2% pace), is enough to squelch the commodity boom, and keep it squelched for a good long while. Not to mention, plunge stocks into correction territory, as we’ve seen lately.When you go on an eating binge, especially with food that’s rich in calories, the body finds a way of correcting your overindulgence. In the same spirit, the world continues to grapple with the aftermath of a 10-year feast of infrastructure spending in emerging markets, which their commodity exports underwrote.Consequently, commodity prices in these markets hit an 11-year low recently.  Countries like Canada and Brazil are hurt because of their exposure to oil, along with other self-inflicted wounds (like Brazil's political turmoil). The Dow Jones Commodity Index is down more than 15% this year.Brazil, which produces a range of commodities from iron ore to oil seed, has fallen far. Moody’s Investors Service downgraded its government debt recently to one grade above junk status, and the real, its currency, just hit a 12-year low. Look at the fate of one of its prime exports, sugar, which has dropped 70% from its high in February 2011. Brazilian sugar growers ramped up output far beyond a sustainable level.In the capital markets, the implications from the commodity crash continue to reverberate. Oil is the biggest problem. Samson Resources, an oil and gas producer that private equity powerhouse KKR backs, plans to file for Chapter 11 bankruptcy protection – it’s the victim of plummeting energy prices. You have to believe other areas of the oil complex are starting to feel some serious pain as well.Oddly, oil output hasn’t dwindled as the result of the price plunge. Due to the global glut, the price is off one-third since June, touching $40 per barrel in mid-August. A brief surged petered out Tuesday. Oil production remains at lofty levels because of the advances in technology.  Extraction costs continue to get dramatically cheaper, although much depends on how attractive the geology of the field is.  Still, with the bulk of output in the first few years of drilling, especially in shale-related territories, the dramatic reduction of rig counts should start to drag down production levels, probably beginning in 2016. Operating rigs are down by more than half from 12 months prior.I continue to believe consolidation is going to happen in the oil patch, especially with cheap capital available.  It is not a matter of if, but when, and with whom.  But that would serve the oil industry only as a bulwark again a long, bad trend. The same goes for other commodities.Follow AdviceIQ on Twitter at @adviceiq.Yale Bock, CFA, is the owner and operator of YH&C Investments in Las Vegas.Y H & C Investments, Yale Bock, his family and clients own shares in the companies mentioned. Past performance is no guarantee of future results. Investing principal in the capital markets is not guaranteed and there is the risk of losing money. The CFA charter in no way guarantees investment results, which will be superior to an index.AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.  

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