By Martin Hutchinson
Contributing Editor
Money Morning

Commodity prices have faltered in the last couple of weeks, and much of the “smart money” is saying the boom is over.

Don’t believe it.

As long as the world’s central banks keep interest rates at these very low levels, the speculative interest in commodities will be strong, and so will their prices. Since only minor central banks yet show signs of moving rates, the commodities bull market has further to run.

The commodities bull has already run a long way. Since Jan. 1, gold is up 20%, silver is up 50%, copper is up 100%, oil is up 110%, coal is up 90% and iron ore is up 60%. In a year of deep recession – with the exception of wimpy gold (which did not decline as much in 2008, because all the monetary “stimulus” made people fear inflation) – that’s a pretty good run.

The Key Catalysts

There are three reasons why commodity prices have been rising, and they’re all still true:

• China and India continue their torrid growth.
• Global stimulus plans are bullish for commodity prices
• And hedge funds and other speculative investors are big commodities players.

Let’s examine each of these in more detail.

1. The “China Syndrome:” While the rest of the world has been mired in recession, China has had a pretty good year, and so has India. China’s third-quarter gross domestic product (GDP) rose 9.5% from the same period last year, and India is expected to post an increase of at least 6%.

That has caused demand for raw materials to soar, because lifting the 2.5 billion inhabitants of those countries out of poverty generally requires lots of goods you can drop on your foot.

For instance, China leapfrogged the United States this year to become the world’s largest automobile market, with sales of 11 million cars and light trucks. China and India show no sign of dropping back into recession. If anything, demand growth in those two countries is likely to continue, which in turn will put additional pressure on global raw materials supplies.

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In general, we have plenty of commodities, but opening up new production takes lots of time and money, so rapid demand growth pushes up prices.

2. Money Talks: Stimulative global monetary policies have tended to push up the prices of all assets – but most notably commodities – in the last year. Those monetary policies aren’t just a U.S. manifestation. Japan has interest rates close to zero and has engaged in lots of “quantitative easing.” Britain has had even laxer monetary policies than the United States, with the Bank of England buying more than $300 billion of British government “gilts.” And China’s M3 money supply grew 28% in the last twelve months.

Monetary policy would have to get quite a lot tighter – with interest rates higher than the inflation rate – before it started choking off commodity prices, and there’s not much evidence of that. Yes, Australia and Norway both raised their base rates by a quarter percentage point in the past two weeks, but both countries are special cases, being commodity producers themselves (Norway produces oil, while Australia produces pretty much everything).

Maybe China is beginning to tighten a little, too. However, the other big boys aren’t. U.S. Federal Reserve Chairman Ben S. Bernanke has said rate increases are a long way off. Britain’s GDP was still falling in the third quarter, so that country won’t be tightening soon. And most of the Eurozone (Spain, Ireland and Greece, in particular) is suffering from huge real estate meltdowns, while other exporting countries worry that the euro is becoming too strong against the dollar – so euro rates won’t rise fast, either.

The bottom line here: Without higher interest rates, the commodity boom will continue.

3. Investors “Get Physical:” Hedge funds and other speculative investors are piling into commodities. What’s more, as I mentioned a couple of weeks ago, they aren’t just buying commodities futures; in many cases, the hedge funds are buying the physical commodities. Since the supply of most commodities is a small fraction of the volume of hedge funds outstanding, prices could shift quite sharply as supply disruptions occur.

Until China and India stop growing or world monetary policy tightens a lot, any blips in the commodities market are just that – blips.

Ways to Play the “Bubble”

There are a number of ways to play a commodities bubble. It’s probably smart not to restrict your buying to gold and oil alone, but to spread yourself among a number of sectors. Let’s take a look at some of the better plays right now available. They include the:

• Powershares DB Base Metals ETF (NYSE: DBB): This exchange-traded fund tracks the Deutsche Bank AG (NYSE: DB) base metals index, thereby allowing you to invest directly in the price movements of non-precious metals. With a market capitalization of $387 million, this ETF is at least reasonably liquid and money has been flowing into it recently.
• Vale SA (NYSE ADR: VALE): Brazil’s largest iron ore producer, and a key supplier to China’s exuberant infrastructure growth, Vale is a true play on the global commodities market. With a historical Price/Earnings (P/E) ratio of about 15, Vale will benefit hugely from further run-ups in the price of steel.
• iShares Silver Trust (Amex: SLV): This fund invests directly in silver bullion, which has been left behind somewhat in its relationship to gold’s price rise – and which can be expected to move up as gold does, possibly by an even greater percentage.
• Market Vectors Gold Miners ETF (NYSE: GDX): Gold miners benefit disproportionately from a rise in the price of gold because their production costs are fixed. This means that miners are a more leveraged way to play gold than the metal itself, particularly as surging speculative demand can increase mining companies’ P/E ratios.
• Market Vectors Coal ETF (NYSE: KOL): China’s power supply is still coal-fired, and demand is soaring, hence global coal prices are likely to be pulled upwards by Chinese demand alone. KOL has a market capitalization of $283 million.

[Editor's Note: Throughout the global financial crisis, longtime market guru Martin Hutchinson has managed to call both sides of the market correctly. During the market rebound that started in early March, Hutchinson assembled high-yielding dividend stocks, profit plays on gold, and specially designated "Alpha-Bulldog" stocks into high-income/high-return portfolios for savvy investors.

But his market calls before the meltdown that started last year were just as important. His warnings about the dangers of credit-default swaps - issued half a year before those deadly derivatives ignited the worldwide financial firestorm - would have kept investors who heeded his caveats out of ruinous bank-stock investments. In fact, Hutchinson even issued a highly accurate prediction of when and where the U.S. stock market would bottom out (a feat that won him substantial public recognition).

Experts are taking notice. And so should you.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and his "Alpha-Bulldog" stocks into winning portfolios. And the strategy is designed to work in any kind of market- bull, bear or neutral.

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News and Related Story Links:

• Wikipedia:
  Quantitative Easing.
• Bank of England:
  Official Web Site.
• Investopedia:
  Gilts.
• Wikipedia:
  M3 money supply.
• Money Morning News Analysis:
  India Begins “Exit Strategy,” But Interest Rates Remain Unchanged – For Now.
• Money Morning Special Report:
  Hedge Funds Take Direct Stakes in Commodities … Should We Be Wary?
• Money Morning Special Investment Report:
  Silver’s Run Quietly Gains Momentum.

Last 5 posts by Martin Hutchinson

• Investors Can’t Ignore a Rebounding Japan - November 20th, 2009
• Open Letter to Timothy Geithner: Is Your Nose Getting Longer? - November 17th, 2009
• It Was a Wonderful Life – And Then Came Securitization - November 10th, 2009
• Has Asia Dethroned Detroit as the Auto Sector Leader? - November 6th, 2009
• Three Ways to Avoid Another Credit-Default-Swap Crisis - October 29th, 2009