Commodities Are 2% Higher This Week – Here’s Why the Rally Can Continue.

Commodities were up big Tuesday (DBC up 1%) as worries over Syria resulted in big rallies in the precious metals and energy. Another piece of stronger-than-expected Chinese economic data (industrial profits were better than estimates) and a weaker U.S. dollar also helped push commodities higher, but really yesterday was all about Syria.

And, showing the benefits of diversification: Although commodities have lagged badly this year, I want to point out that while most major global stock markets are down around 2% so far this week, the commodity ETF DBC is up 2.3%, to a 4+ month high.

Since Syria was behind the moves in commodities, instead of recapping the moves in the energy and metals markets (energy, including oil, was up about 2.5% yesterday, while gold rallied 1.5% and silver 2%), it’s more useful to explain exactly why Syria matters, and whether it’s going to be an ongoing positive for the commodity markets.

First, we’ve got to think about Syria in the context of everything else going on in North Africa and the Middle East.  Egypt, which continues to teeter, has been pushed to the back burner, but the debate about whether to suspend U.S. aid is still ongoing.  If the U.S. suspends aid, that’s a serious blow to the military-controlled government.  The Saudis, the world’s No. 2 oil producer, have expressed support for the military rulers, so if the U.S. does suspend aid, we can assume the Saudis will be none too pleased.

Now let’s move on to Syria, where we are considering a military strike.  The Russians, the world’s No. 1 oil exporter, support Syrian President Bashar al-Assad’s regime. It’s very safe to say that they will be upset by any U.S. military strike, as they want to see the current administration stay in place.  And, the Syrian conflict has further cooled already-frosty U.S./Russian relations. (Russian Deputy Prime Minister Dmitry Rogozin said on Twitter yesterday that “the West behaves toward the Islamic world like a monkey with a grenade.”)

So, there are two situations where U.S. interests seem, potentially, at odds with the world’s two largest oil producers.  Point being, while it’s unlikely that either situation will escalate too much further (even if we strike Syria it’s likely to be very limited, which will result in Russian criticism in the press but little else), the potential fallout, if either one does escalate significantly, is serious with regard to the world’s immediate energy needs.  That is why Syria, a country of approximately 145K bbls/day of oil production, is causing so much consternation right now.

WTI crude yesterday broke through resistance at $108/bbl and hit a new high for the year, as geo-political premium is pumped into the contract.  Gold also rallied through resistance at $1,400/oz. and silver traded through the $24.43 level, breaking a downtrend in place since last fall.

The rules of technical trading say that we should buy gold, silver and oil here, as they’ve broken through resistance and made new multi-month highs.  But, I have a very hard time buying anything when an extraneous event like Syrian military conflict is behind the move. That’s because in reality we’re just guessing, as we’ve got no edge or insight as to when and how the U.S. will strike Syria, and what the reaction will be.  And, guessing with no discernible edge in this business inevitably leads you into trouble.

So, if you’re long commodities and made the good buy back in June and July, I think you enjoy this rally. However, just realize it’s fickle and that, if the global macro backdrop settles down, we’ll see WTI and gold give back yesterday’s gains.

But, more importantly, looking beyond Syria, I believe both gold and oil are seeing the environment get more-bullish for the remainder of the year. If we see continued progress in the global economy, expect consistently higher prices once all this Syria turmoil settles down.

And, I think the commodity space in general, while a bit overbought, continues to offer an attractive place for incremental capital and potential outperformance between now and the end of the year.  If you’re not long commodities already, though, I’d be inclined to wait for a pullback before getting broad commodity exposure via DBC or a similar ETF.