Update on Commodities

The general direction of commodities in the next year or so will depend on everything else.  The biggest thing to watch is whether the Fed fully goes through with QE2 and, if so, whether the banks lend this money out or hold on to it as excess reserves.

There is also an issue of velocity, or the demand for money, but this may be determined by the supply of money active in the economy.  If this new money stays locked up in the banks, then price inflation may be minimal in the near term.  We may see the stock market retreat and see signs of another (or continuing) recession.  Either way, we will continue to see high unemployment.

If the banks start lending money, we could see a sharp rise in the money supply that is not being held by banks.  We will see the fractional reserve process take over.  This could also lead to an increase in velocity, where people would rather spend their money on "things" than keep it sitting at a bank and depreciating.

If the banks do start lending out this money, expect commodities to do very well.  Some will do better than others.  Silver may do better than gold.  But in the first scenario where banks don't lend this additional money, gold will fall less than silver.

Oil will follow the same trend.  A recession will keep oil from rising dramatically.  If banks lend like crazy, then the price of oil will probably go up like crazy and that is under the assumption that there will be no new conflicts in foreign nations.  If there are new conflicts, particularly in the Middle East, then oil prices could go to the moon.

Food is another commodity that will go up with high price inflation.  Owning a mutual fund or ETF that invests in a broad range of food will do well in such an environment.

In an environment of high price inflation, expect commodities to go up even higher.  That is why they are important for an investment portfolio.  TIPS (government bonds that adjust for inflation) will not serve you well.  Even if the CPI were accurate, the bonds would only be going up as much as the price inflation indicator and no more.  This is not a good hedge against inflation.