Out of the Shadows

 | Dec 19, 2011 | 9:30 AM EST
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We're in the middle of witnessing one of the great changes in the pricing mechanism of the commodities we all depend upon -- oil, copper and zinc – and understanding these changes is crucial to knowing how to invest in the next inevitable commodity boom.

And that boom is coming.

I spent three years researching and writing a book about the financialization of oil called Oil's Endless Bid, in which I posited that oil (and other commodities) have morphed into asset classes and, therefore, were less reliably priced to their fundamentals than to their financial influences.

The greatest inputs into those financial influences on prices were coming almost exclusively from the investment banks during the last decade, particularly from the commodity powerhouses of Goldman Sachs (GS) and Morgan Stanley (MS).

Anybody who's even superficially following the trajectory of the investment banks and their stock prices knows that times are changing quickly. Fighting through a recession and its huge deal slowdown, combined with a crisis of confidence and the trifecta of Dodd-Frank and Volcker Rule pressures, the investment banks have been disabled in their preeminent role in commodity trade. They still do just fine, thank you, but their first dibs at the best deals and most profitable trades in oil and base metals has been waning.

And who has taken up the slack? A group of shadowy, mostly privately owned companies based in Switzerland, out of the view and reach of regulators, but also out of the thoughts of investors. Let me name the three largest of these commodity powerhouses for you: Glencore International, Vitol and Trafigura.

Never heard of them? You're not alone. But these are names you need to know and follow if you want to understand when the next commodity boom is coming and just how fantastic it will be.

Case in point: Trafigura, the world's second-largest metals trader, behind Glencore, just posted a profit of $1.1B for the year, a corporate record, up 62% from 2010. There was some extra volatility flashpoints in 2011, both for metals and oil, but a 62% increase of profitability is a function more of the company's ability to swipe large percentages of the commodity deal flow from the U.S. and European investment banks in the past year.

If you believe, as I do, that the profitability of commodity trading is directly related to the prices paid at the pump for gas and the prices the housing industry pays for raw copper pipe, then you won't be surprised by the incredibly sticky oil price we've seen this year above $105 a barrel and copper that averaged close to $4 a pound.

That billion-dollar profit came from somewhere.

But how can we take advantage of this trend the next commodities boom from it? There's one way besides tracking the profits of Trafigura and others. Glencore, the largest of these companies, went public this year on the London Stock Exchange and has been forced to slowly disclose its earnings and profit mechanisms. Watching this one stock can give us a great insight into the next great commodity wave.

Since its initial public offering in the spring, Glencore shares (GLEN.L) have traded mostly down, presaging the moderate fall in prices of copper and oil. It's been a great tell on the move down in these commodities – and I expect it will tell us of the next move up. Since summer, Glencore's shares have been building a base between 365 pence and 435 pence a share. This is the key level to keep an eye on. A break below that level would definitely indicate a copper moving below $3 a pound and an $85 target for crude. A break above would have me looking for a retest of the $4.50 copper highs and a $115 a barrel crude price.

Of course, you could directly invest in Glencore shares and try to capture the good fortunes of these new trading monsters. I've owned shares for a while, and they should be considered very speculative investments. You are, in essence, betting on traders -- but in this case, you are betting on very talented and well-connected traders, indeed.

But direct investment isn't necessary for good vigilance and keeping an eye on the fortunes of Glencore and the other big -- mostly private -- commodity traders. They'll give you great insight into the next big move for commodities in 2012.

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