Profiting from the Collapse in Commodities

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

This week’s Global Bull Market Alert pick is a bet that one of the few trends — the collapse of global commodities prices — has further to go. And the best way to profit from this is through the PowerShares DB Commodity Double Short ETN (DEE).

Much like the remarkable rise of the U.S dollar over the past few months, the collapse of commodity prices took most financial pundits off-guard. After all, up until July, the conventional wisdom was that the commodities were in the midst of a “supercycle.” Commodities of all shapes and sizes were set to go sky high for as long as the investment eye could see. T. Boone Pickens said oil would never again go below $100 a barrel. Alexei Miller, CEO of Russia’s oil giant Gazprom, predicted that $250 oil was “in the foreseeable future.”

What happened was a big — and sudden — surprise. Oil has plummeted from $147 in July down to around $42 per barrel. Metals such as aluminum and agricultural commodities such as wheat and corn have followed suit. And both T. Boone Pickens’ hedge fund and Gazprom’s stock price are down by more than 80% during the last few months.

Despite these large (and unexpected) falls, there is no real end in sight to the collapse in commodity prices. The global financial crisis is now making its effects felt in the “real economy” through a rapidly spreading global recession. The economies of the United States, Japan and Europe are all in recession for the first time since World War II. Demand from other developed economies and the fast-growing BRIC economies has collapsed. Last week, Merrill Lynch forecast that oil may fall below $25 per barrel in 2009 as a global recession takes hold and China’s economy slows further.

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Equally importantly, it’s now clear that the speculative fervor behind much of the sharp rises in the prices of commodities has evaporated. With the air having been let out of the commodities bubble, and global deflation posing more of a threat than inflation, it will be awhile before the commodities bull gets back on track. Yes, we will see $147 oil again one day. Just not in the near future.

The best way to profit from this trend is through the PowerShares DB Commodity Double Short ETN (DEE). DEE is a leveraged investment and replicates, net of expenses, twice the inverse of the Deutsche Bank Liquid Commodity Total Return Index, which itself consists of commodity futures contracts based on crude oil, heating oil, corn, wheat, gold and aluminum.

So buy the PowerShares DB Commodity Double Short ETN (DEE) at market today, and place your stop at $60.

Here are a couple of caveats about this week’s pick. Because it is a leveraged play on commodities, you can expect it to be highly volatile. So you may want to take a smaller position in it than normal. DEE also has a lot of momentum behind it, and therefore is susceptible to sharp corrections. Once the position starts moving in your direction, I’ll be tightening the stops on this position pretty quickly to lock in profits.

Portfolio Update

As expected, the European Central Bank (ECB) cut interest rates by 75 basis points on Thursday. This is bullish for your position in the Market Vectors Double Short Euro ETN (DRR).

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The Bank of England slashed its key interest rate by 100 basis points the same day, and the British pound sterling hit a six and one-half year low against the U.S. dollar. This is good news for your short position in the CurrencyShares British Pound Sterling Trust (FXB). Tighten your stop to $157.00.

The news about the euro and the U.S. dollar — combined with Sweden’s interest rate cuts last week — are all bullish for the Direxion Funds, Dollar Bull 2.5x Fund (DXDBX).

Your two positions in the Japanese yen — CurrencyShares Japanese Yen Trust (FXY) and the ProShares Ultra Yen (YCL) — both hit record highs on Thursday, with FXY breaching the $108 level for the first time. Tighten your stop in FXY to $98.50.

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The European Central Bank (ECB) is expected to cut interest rates by 50 to 75 basis points tomorrow after reports confirmed that inflation is not much of a problem in the Eurozone. With the U.K. economy sliding deeper into recession, the Bank of England is increasingly likely to slash its key interest rate for the third time in as many months and may prompt the government to launch a second fiscal stimulus package next year.

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