Commodities Binge Is Under Way, But Market Realities Loom

By webadmin on 09:58 pm Jun 03, 2009
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Jonathan Leff

Singapore. Optimism, a necessary precondition of a global economic recovery, could also be the undoing of the commodity price rally if producers focusing on future demand put their faith in a forex-driven price rally.

The growing din of analysts warning of the schism between economic sentiment — which in May fueled the biggest monthly commodity price rise in 35 years — and fundamental market realities has become a cacophony. Finding one who believes that oil, metal and other prices can continue to gain without a correction is rare.

And, some say, every day that prices continue to defy depressed demand, swollen inventories and idled capacity move the market closer to an even deeper and steeper decline.

With commodities, fund-fueled investment not only flies in the face of fundamentals, it also threatens to wreck them — unlike high stock or bond prices, high oil, copper and wheat prices can stimulate supply and deter demand, making what many analysts say is a bad fundamental situation even worse.

While there are few signs of that happening as yet, analysts say it may only be a matter of time before more supply begins seeping into a market that’s still ill-prepared to absorb it, whether from OPEC producers, Asian steel mills or copper miners.

“Outside of the core Middle East producers, there is always the risk of OPEC quota slippage,” said Jeff Brown, managing director for consultancy FACTS Global Energy. “We have seen it many times in the past as prices stabilize — after the initial panic due to a decline in price, some producers start to relax.”

For the moment, most producers are viewing the gains with a healthy dose of skepticism, but there are early indications that some are buying into the consumer hope and investor hype.

Most notable is the Chinese steel industry, which an official said on Tuesday had ramped up output to its highest level since February, when news of Beijing’s $585 billion stimulus last encouraged a production surge — only to see prices crash when builders proved to be less keen than the steelmakers themselves.

And demand could come under pressure as higher costs filter into economies that are barely emerging from the worst recession in generations. China raised motor fuel prices by up to 7 percent on Monday, its biggest increase since last June, while India has said it will move toward free-market pricing of domestic fuel.

Those elements threaten to further undermine a rally that most analysts view as precarious to begin with.

“If market sentiment turns negative again, the focus will shift back to current fundamentals, which remain weak, and prices will go down,” said Societe Generale analysts, including oil research head Michael Wittner.

“The risk of a significant correction,” for oil, “back down to $50 or even lower, remains significant.”

The Reuters-Jefferies broad commodity index surged by nearly 14 percent in May, outpacing even last year’s rally for the biggest gain since 1974. Oil led the way with a 30 percent surge, rising, as copper did, to a seven-month high.

Unlike two years ago, OPEC producers now have 6.4 million barrels a day of spare capacity that they could begin to uncork; steel mills and smelters worldwide could fire up their furnaces within days. Even gold, where the vagaries of supply and demand typically take second seat to financial flows in terms of influence, has encountered fundamental obstacles to rallying beyond $1,000 an ounce.

Still, even downbeat analysts like Harry Tchilinguirian, of BNP Paribas, acknowledge that markets may be waiting for a mythic correction that fails to materialize. He said John Keynes’s adage comes to mind: “The market can stay irrational longer than you can stay solvent.”