Friday, May 30, 2008

Agricultural Commodities vs. Base Metals

I’ll be the first to admit that I am sometimes guilty of oversimplifying the commodities world by lumping all commodities together for the purpose of making broad comparisons between equities and commodities. When I break out a particular commodity, it is usually crude oil or gold.

In fact, the recent action in agricultural commodities and base metals has been at least as interesting as the action in the energy and precious metals baskets. Many of the same factors – supply and demand, inflation, geopolitics, etc. – are at work across the full spectrum of commodities. Sometimes the geopolitics of agricultural commodities and precious metals are on par with that of oil politics. Just ask the Chinese…

The chart below compares the ETFs associated with the PowerShares Deutsche Bank Liquid Commodity Index – Agriculture (DBA) with the comparable ETF for base metals (DBB) over the course of the 17 month life of the ETFs. The chart shows three distinct internal trends within the broad commodity sector: the strong metals performance for the first four months of 2007; the sharp rally in agricultural commodities relative to metals during the remainder of 2007; and the more recent (albeit less dramatic) tilting of the pendulum back in the direction of base metals.

At the moment, both agricultural commodities and base metals are struggling to hold on to gains made over the past six months. There are a myriad of ways in which to invest in commodities over the long-term or to take short-term speculative positions. When thinking about the latter alternative, do not overlook a pairs trading approach.

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