Commodities Aren't Done Yet

If you believe the headlines, the long run in commodities prices ended last week. But retirees shouldn't start celebrating just yet. Before you begin scaling back your inflation expectations and make changes to your retirement portfolio, get some longer-term perspective -- and see how small last week's correction looks compared to price gains in recent years.

Many retirement investors have looked for a way to diversify their portfolios to protect themselves from inflation. The rise in the popularity of commodities has led to a number of new investment vehicles, such as exchange-traded funds tied to the price of oil, gold, and other materials. Given how volatile the commodities markets can be, however, those who've profited from gains may be the first to head to the exits when the music stops.

No shortage of drama
The reversal in commodities came shortly after two of the most popular ones -- oil and gold -- achieved new highs with true psychological importance. Late last month, oil held the $100 level, and climbed above $110 per barrel until last week's slide brought prices back down to the century mark. Meanwhile, gold broke $1,000 per ounce briefly, trading as high as $1,030 before a dramatic two-day drop that knocked $80 off its price.

As you'd expect, panic gripped investors in stocks that have performed well during the commodities boom. Farm services companies immediately felt the hurt, with seed-producer Monsanto (NYSE: MON) dropping 12% and fertilizer-maker Potash (NYSE: POT) falling 10% last Wednesday. On the mining side, losses were even more severe, as Newmont Mining (NYSE: NEM) took a 14% hit for the week, while North American Palladium (AMEX: PAL) fell 26% as the entire platinum-group was looking far from precious.

What a difference a week makes
What was more surprising than these big price moves, however, was the quick change in Wall Street sentiment toward commodities. After years of gains, many market professionals started pointing to the correction as the definitive end to the bull market in commodities. Consumers, who've suffered greatly from rising food and fuel prices, couldn't have asked for better news in the face of financial concerns and a possible recession. And companies like Kraft Foods (NYSE: KFT), for whom higher grain and dairy prices mean lower profit margins, reacted positively as well.

Yet for those who found short-term relief in seeing last week's big correction, a longer-term perspective should restore a healthy skepticism about whether commodities prices are starting a lasting downtrend. Gold is still up almost 10% since the beginning of the year and has risen more than $200 per ounce just since last September. Although a $10 drop in oil is a good remedy for pump pain, oil prices are still tenaciously hanging onto triple-digit levels and are up more than 40% since last summer.

Volatility is everywhere
The move in commodities is just another example of how risk is returning to the risk-reward equation for investors. After years of easy, painless gains, markets of all types are reminding everyone that what goes up occasionally goes down.

Just because markets suffer a one-week hiccup, however, doesn't mean that it's time to dump everything and get out. If you've made big profits from investments in companies like Rio Tinto (NYSE: RTP) or ExxonMobil (NYSE: XOM), you may want to trim back your positions -- especially if they've grown to be disproportionately large in your portfolio.

In general, though, having part of your portfolio tied to the fortunes of commodities markets can be a useful way to hedge against inflation risks in retirement. With the world's appetite for raw materials continuing to expand, don't be surprised to see commodities hit new highs again in the near future.

See these articles to learn more about

• How you can retire early and get penalty-free access to your IRA.
• Whether your retirement is at risk.
• How diversification has its downside.