Commodities | Sep 19 2006
By Chris Shaw
Commodity prices have struggled in recent weeks and this is creating uncertainty for investors as there are now emerging the first comments suggesting the “Supercycle” for commodity prices has now ended and conditions are changing and taking commodity prices down with them. But as with all markets there is a divergence of views, particularly as to the timing of any finish to the boom in the commodities sector.
In one corner is ABN Amro, who notes the CRB Index has broken its long-term uptrend in recent sessions, a move that suggests to the broker the long-term uptrend in commodity prices has been broken.
In its view, the reason for the recent weakness in commodity markets is the hot money from hedge funds and speculative positions is being withdrawn as investors become more cautious on the outlook for the global economy.
It isn’t a view shared by Morgan Stanley economist Andy Xie, who suggests the end is not yet near for the commodity price cycle as the conditions are not yet in place for this to occur.
Xie suggests the bull market for commodities will finish at some point, but the end of the boom is more likely to be late next year or early in 2008 and will be the result of either a global recession or rising interest rates. Most experts seem to agree the former is unlikely in the short-term, while the markets are now factoring in interest rate cuts in coming months rather than further increases, at least in the US.
In Xie’s view the current price correction is just that and doesn’t yet signal an end to the period of strong commodity prices, as while copper has fallen from more than US$8,700 per tonne to around US$7,400 per tonne it is still more than double the average price for last year. Nickel paints a similar picture, as currently its price is more than twice the average for last year and more than four times the average level in the 1990s.
Also supportive for prices in Xie’s view is the industry is simply now much larger than it used to be, with the number of professionals working in the commodity sector having increased as much as tenfold over the past few years. He suggests it is in their interests to continue spruiking the sector as an asset class, something that appears to be working given the IMF reports more than US$35bn flowed into commodity funds over the past year. In this respect the performance of the sector in recent years resembles the dotcom boom on the late 1990s as it is the hot sector for speculative money, with Xie seeing the likelihood of a similar bust, just not yet.
His colleague in New York Stephen Roach agrees, pointing out commodities have moved in recent years from being a pure play on a physical asset to something approaching a financial asset in their own right. This is fine as it goes in Roach’s view, but leaves commodities open to speculative excesses and these excesses have come into play in the past 12 months or so.
He also suggests something that may be of more concern for commodity investors – China may not be the driver in future years. There are two reasons behind this way of thinking, as firstly Roach expects the Chinese to eventually be successful in slowing down the rate of growth in the economy. Secondly, he takes the view there will be a push towards more efficient use of energy and other commodities given the benefits of such a change over the longer-term. This changes the demand side of the commodity equation, which supports a weakening of prices given the likely supply side response in coming years.
This will all take some time to flow through though, adding weight to the argument the commodity cycle has not yet turned down. Xie expects over the next few quarters the inflation threat in the US will again take centre stage, so rather than interest rates moving lower they will have to be raised further to restrict demand. Additionally, ongoing increases in Asian land prices, especially in China, are inflationary by nature and will continue to flow through, putting upward pressure on global inflation. As a result, Xie suggests rates simply have to go higher to counter this threat, and at this time the commodity bubble will end.
In terms of the implications for global markets, ABN Amro suggests Asia ex-Japan should outperform other emerging markets under such conditions given the region is a major commodity user. Company earnings should benefit from any fall in commodity prices generally and the oil price in particular, so the broker is attracted to industrial, construction and transport companies in the region.