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April 5, 2006

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Commodities Are Going Buggy!

Name: Phil Flynn

Company: Alaron

Learn More About Today's Author
Years Trading: 19

Favorite Movie: Patton

Commodities Are Going Buggy!

Commodities are on fire. And traders are being attracted to these historic moves almost like a bug to a light. Gold bugs who have waited decades for this moment to arrive are bugging out with joy at the sight of this incredible bull gold market. Their hearts have fluttered with joy as gold just recently achieved a 25-year high!

Silver Beatles (which I think of is the equivalent of a gold bug who likes silver) are flying high as the market surges to the highest levels since the 1980’s. There hasn’t been as much excitement about the silver market in years since its glory day back in the days when the Hunt brothers were trying to corner the market. Where are those Hunt boys now?

Oil fleas are coming out of the woodwork to embrace the sharply rising price of oil. There is no doubt that commodities are bugging out and it seems everyone just can’t wait to get on board and money is flowing in like crazy.

Paper is out and rocks are in. In other words, it seems the market's love affair with paper such as bonds and currencies seems to be at least at some levels being replaced by the old time desire to own hard assets. Things you can actually hold and put your hands on, something substantial and something with a timeless value. Gold, Silver, platinum, oil copper and zinc, the "old time hard assets" are finding their way into portfolios once again, and in some cases are becoming the main focus of some portfolios as well. Because these desires are running high with the commodity boom, it seems that everyone is now realizing the potential of the commodity bull market and is looking to get in on the act.

Exchanges are rushing in to offer new products and new platforms. In previous articles, I have written about the New Era of commodities. Commodities that seemed to be shunned throughout most of the 1990’s are now very much the place to be. How commodities have a tendency to cycle from all time highs to all time lows to all time highs again. I spoke of how that we are now in a cycle that could see incredible returns on these markets, potentially for many years to come. It has become obvious to many that now is a very special time for commodities.

Of course, for the average investor, sometimes it is hard to find the best way to take advantage of these moves. When it comes to precious metals, for example, there are many ways to take advantage of the market. You can actually go out and buy gold or silver coins. But sometimes that markup on the price might be a bit too high. You can save a lot of money by buying gold and silver directly through the futures market, but for many that may be a little more silver and gold than they are bargaining for. Or you could just speculate in the futures and options markets which you can do sometimes for pennies on the dollar - but of course, with that leverage also comes a great deal of risk.

When it comes to oil, it is even a bit more difficult. It’s not exactly like metals in the sense that you don’t go out and buy a few cans of oil and sit on them with the hopes of selling those cans at a later date. You of course can use the futures market to trade futures and options, but that too might not be for everyone. You can try to take advantage of the move by buying oil company stock or perhaps drilling or service stocks, but that also might not really reflect the exact movement in the underlying commodity.

So now there are rashes of new products that are vying to grab a piece of the investor’s dollar and cash in on the commodity boom. Silver has exploded on strong fundamentals. Demand for silver has been incredible. Whether it’s from China or India, silver has been on fire. Yet silver in recent weeks has been flying on the exciting announcement that it will now be traded as an Exchange Traded Fund or ETF for short. This caused a big rally in silver. And now there is talk that soon the American Stock Exchange will offer an ETF on energy products. That may also cause a big run-up in energy.

You may be familiar with ETF’s such as SPDRs (spiders) on the S and P 500, Diamonds Trust, and QQQ’s on the NASDAQ 100, and ETF’S on the Dow. ETF’s are security certificates that state legal right of ownership over a basket of individual stock certificates or now in our case silver or oil. Financial firms need to buy the underlying stock or in this case commodity to make sure the value of the fund reflects the true value of what the fund is supposed to track. For Silver that backer is Barclays Global Investors. Then shares of the ETF are bought and sold. And whether or not you own the shares of the ETF, recent action shows that a creation of and ETF on a commodity may actually inspire that commodity to rally in anticipation of that announcement. And then there was much excitement and anticipation when it was announced that it was possible that we would now have an exchange traded fund for oil and oil products. The AMMEX is starting an ETF on energy assuming it is approved by the SEC. Investors Business Daily recently touted the joys of using ETF’s by saying “using ETF’s and open-ended mutual funds results in better performance than sticking solely to either type of investment vehicle," according to some money mangers. In other words, the joy of diversification and a hot commodities market have brought the introduction of ETF’s.

For some time, we have also hadcommodity indices that track a group of commodities. For example, we have the CRB Commodity Index, the Dow-Jones AIG Index and The Goldman Sachs Index as well. For years, these have acted as vehicles to trade a wide range of commodities in one contract. But they didn’t really address all the needs of investors who wanted to invest in a particular commodities sector. The quest to find new ways to cash in on investors desires to invest in a single commodity was not lost on those that carry some of the traditional commodity indexes.

The Wall Street Journal reported that it would add twenty “single-commodity” sub-indices to its Dow Jones-AIG commodity Index because of increasing interest in commodities as an asset class. Obviously this move is in response to the potential popularity of the Exchange Traded Funds. According to the Journal there is currently $24 Billion in assets tracking the Dow-Jones-AIG index, which has attracted investors and funds that have been attracted to commodities by major moves in both oil and metals. These new indexes will likely compete with new commodity ETF’s which are just on the horizon.

What is clear by the exchanges and fund mangers trying to get involved with this booming market is the average investor should also start to examine the possibility of adding commodities to your portfolio. Whether you want to buy stocks that track commodities, or ETF’s actually venture into the actual futures market, it appears that we are on our way to an incredible run. The purest way to play the commodity boom is in the actual futures markets. Still, the risk is high and should be considered before investing. The money invested in futures should always be money you can afford to lose. If you cannot afford to lose you can't afford to win. Unlike some investments in other areas, you have to be very aware of commoditie's dramatic movements. It is usually recommended that if it is your first time in getting in commodities that you find a broker that will help you monitor your account and help with all the variables that come with futures trading.

Options offer limited risk but need to be monitored closely at expiration as in the money options can be automatically exercised, giving you an actual futures position. If that seems too complicated then maybe you should explore ETF’s or possibly buy coins. But if you can afford it, try to be part of the most exciting rebirth of this exciting and historic asset class. It seems unwise to be on the sidelines in a sector that is on fire. You may not be a gold bug or a silver beetle but you shouldn’t ignore the exciting possibilities of commodities. If you try to ignore it at some point it is bound to bug you.

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