Financial Markets Alert – May 11, 2011

Commodity Market Selloff
Financial Market Impact

Dow Jones Industrial Average -130.25 (-1.02%)
West Texas Intermediate Crude Oil (barrel) -$4.90 (-4.72%)
Silver (troy ounce) -$3.27 (-8.5%)

Today the price of oil dropped nearly five-dollars per barrel to $98.98. Energy and commodity stocks have fallen in response to the lower crude prices.  The 130 point drop in the Dow Jones Industrial Average (DOW) is largely attributable to commodity companies.  Just three commodity sensitive companies (Exxon, Chevron, and Caterpillar) are accounting for over 60 points of the DOW decline.  Precious metals may also be in the middle a cyclical collapse.  An ounce of Gold has slipped -4% since reaching $1,563 on May 2, 2011 and the price of silver has declined over -7.5% just today.  This brings the total decline in silver to -26.83% in the last nine trading day (All return data provided by Bloomberg, LLP).

Market Decline Factors

  • Oil inventory data released for the week ending May 6, 2011 showed an increase in U.S. oil inventories (U.S. Department of Energy).  Since April 1, 2011 this inventory has grown 3.5% (Bloomberg, LLP).  Although a modest increase, it came during a time of climbing oil prices.   
  • Precious metal prices are dramatically higher from hedge fund participation and speculative investors. The bubble that has developed in precious metals may be susceptible to a rapid retracement.  Silver is experiencing this decline currently and gold prices may follow soon.
  • History has demonstrated that precious metal bubbles can burst with extraordinary consequences.  When the last gold bubble collapsed in 1980 the price of gold fell 42% in less than two months (Bloomberg LLP).

Market Effect

  • The decline in commodities has predominantly affected a small sector of stocks.  Consumers and manufacturers may actually benefit from lower input and gasoline prices.  This is a long-term advantage to a diversified portfolio.
  • Avoid investments that are highly correlated to the commodity sector or use derivatives to gain investment exposure.  The popular DB Commodity Index Tracking Fund (DBC) uses futures contracts on just fourteen commodities.  This fund has exploded to over $6.8 billion in assets in just over five years (Source: Morningstar).  Not surprisingly, this Exchange Traded Fund (ETF) has lost -9.46% since April 29, 2011 (Bloomberg, LLP).
  • The selling of energy and commodity investments during the last two weeks may indicate that the “commodity trade” is coming to an end.

Our Approach

  • The DCM large cap portfolio has reduced the exposure to the energy and commodity sector as a result of the peaking in energy and commodity prices.
  • Currently the exposure to energy stocks in the DCM large cap value portfolio is only 6.78% versus the Russell 1000 value benchmark weighting of 13.17%.
  • The DCM large cap value portfolio is finding better valued opportunities existing in the healthcare, technology, and financial sectors.
  • The DCM diversified portfolios have also been constructed to underweight commodities and overweight healthcare, technology, and financial sectors.
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