With investors on the lookout for higher interest rates, the knee-jerk response would be to buy oil and other commodities as a hedge against inflation.
Typically, the Federal Reserve raises rates to try to ward off inflation, so investors sometimes use higher rates as a tip-off to buy oil, copper, gold, corn and other commodities, or mutual funds that invest in commodities.
But in the unusual environment of the last couple of years, many experts aren't looking at the prospect of increased interest rates as the usual trigger to buy commodities. Instead of inflation, they see ongoing subdued prices and continued threats to economic growth — and commodity prices — as consumers pay off their debts, homebuilders wait for customers, and companies get along without hiring. Analysts are concerned that commodities are already expensive after running up in anticipation of an economic recovery.
"The Fed faces no imminent inflation threat," said Barclays Capital commodity analyst Sudakshina Unnikrishnan. "But it does need to pull policy back from crisis settings as the economy and financial system improve."
And as the Fed and other central banks throughout the world prepare to wean their economies from trillions of dollars in life-saving infusions, commodities and stocks could be vulnerable, rather than attractive, investments, experts say.
When interest rates climb, especially if they rise quickly, that stunts demand for commodities as companies face higher expansion costs and struggle to build profits, said Robert W. Baird strategist Bruce Bittles, who sees no urgency to buy commodities now in response to expected higher rates.
While some experts are leery of adding commodities at this point, many advisers still recommend that investors hold a portion of their portfolio in commodities, perhaps 5 percent, at all times.
Although the price of crude oil, in particular, has attracted significant attention of late, both oil and gold have lagged the stock market this year after rising sharply in 2009. Shares of energy companies, often a popular investment amid rising oil prices, have been volatile, but have underperformed the broader stock market since the end of 2008.
In a survey of professional investors, Citigroup small- and mid-cap strategist Lori Calvasina found bearishness on commodities mounting. Basic materials stocks are perceived as "extremely expensive" relative to likely profits, said Calvasina, who notes building materials, metals and minerals, steel and diversified chemicals appear the most expensive and unattractive of all sectors.
In the oil sector, Barclays analyst Paul Horsnell notes, "European oil demand recorded its greatest ever year-over-year fall in January, following on from months of extremely weak" demand. Although demand will improve, he says, "consensus forecasts are still far too optimistic."
For the U.S., the International Energy Agency is forecasting no growth in oil demand this year. Horsnell expects demand to increase slightly, although it is "not exactly rampant."
The sweet spot of the world is China, and Horsnell said that through that prism, oil demand "looks quite insanely strong."
