Why May’s Stock Market and Commodities Gains Can Continue

By: John_Derrick

The book is closed on May, and what a great month it was for commodities, precious metals and emerging markets. And there are several good reasons to believe that the strong performance will continue in June and beyond.

The price of oil rose nearly 30 percent in May to close above $66 a barrel. This was oil’s biggest monthly gain since March 1999, when it climbed more than 36 percent. Natural gas picked up 14 percent, reversing its negative trend so far in 2009.

Gold was up more than 10 percent in May, its best month since November, and is once again nudging close to the $1,000-per-ounce mark. Silver turned in its best monthly showing in more than two decades – the futures contract for July delivery rose 27 percent.

It was a good month for copper – up about 9 percent. It’s now up more than 57 percent year-to-date. The Reuters-Jeffries CRB Index, which measures a broad basket of hard and soft commodities, gained 14 percent in May, its best month since the summer of 1974.

In key emerging markets, India’s Sensex index increased 28 percent in the month, while Russia’s RTS index popped 22 percent. Double-digit gains were also seen in Brazil and Turkey, among others.

We have been seeing signs of improving health in the global economy for a few months now in terms of better-than-expected economic growth rates, industrial production, consumer confidence and other measures. The positive indicators prompted OPEC’s secretary general to say Friday that he expects oil prices to be as high as $75 a barrel by year-end.

But the primary driver for oil, gold and commodities is the weakening dollar, and there is little reason to think that the dollar will strengthen any time soon. The dollar hit a five-month low against major currencies on Friday.

Expectations of massive federal deficits for years to come – both to recover from the financial meltdown and to pay for President Obama’s ambitious social programs – will serve to undercut the dollar’s value. On top of that, economic growth is likely to be stronger abroad than in the United States.

The dollar’s precarious standing has contributed to fears of waning demand at future Treasury auctions. China, the largest U.S. creditor, has made it clear that it disapproves of Washington’s monetary expansion policies and that it has little appetite for adding to its huge holding of U.S. government debt.

Treasury officials held their breath going into a sale of $26 billion worth of seven-year notes on Thursday. That auction went off successfully, but the fear that buyers will stop showing up remains.

A failed Treasury auction could be catastrophic for the dollar.

The Federal Reserve would have to step in as the buyer of last resort – to do so, it would have to print new money, which would add to the downward pressure on the dollar, which would make dollar-denominated Treasury securities less attractive and harder to sell, which would force the Fed to print even more money to buy even more Treasuries, which would further hurt the dollar… you get the idea.

The second quarter usually sees seasonal weakness, but the first two months of the current quarter have defied that historical tendency. China usually sees a slowdown in the second quarter, but not this year.

One possible explanation is that after such a big overshoot to the downside in the two previous quarters, we are now seeing markets swing back toward a balance. If that’s the case, it’s one more reason to be thinking positive.

By John Derrick,

John Derrick, CFA, is director of research at U.S. Global Investors, which manages mutual funds specializing in natural resources, emerging markets and global infrastructure. 

For more insights and perspectives from the U.S. Global Investors team, visit CEO Frank Holmes’ investment blog “Frank Talk” at www.usfunds.com/franktalk.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Gold funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The price of gold is subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in gold or gold stocks. The following securities mentioned in the article were held by one or more of U.S. Global Investors family of funds as of 12-31-07 : streetTRACKS Gold Trust.

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