After $99B collapse, rally seen for commodities

The commodities rout that knocked off $99 billion of market value two weeks ago is driving out speculators and leading The Goldman Sachs Group Inc., which forecast the plunge, to predict a possible recovery. The combination of slower growth in U.S. service industries and fewer German manufacturing orders helped drive the S&P GSCI index of 24 commodities down 11% in five days, the most since December 2008, and erased all the gains since mid-March. Gold, wheat and zinc rebounded at the end of the week as U.S. payrolls exceeded economists' forecasts, reducing concern that demand would weaken. “Given the magnitude of the pullback, it does create an opportunity for more upside potential, particularly in the second half of this year, when fundamentals are expected to tighten,” Jeffrey Currie, head of commodities research at Goldman, said May 6. A month ago, he told investors that they should be “underweight” in commodities. The value of all 24 commodities tracked by the S&P GSCI index was about $805 billion May 6, compared with $891 billion April 29, according to data compiled by Bloomberg on the number of outstanding contracts and prices of futures closest to delivery. Combined holdings of exchange-traded products backed by precious metals fell to $119 billion, from $132 billion, the data show.

INVESTMENT FUNDS

Speculators retreated after investment funds made near-record bets on price gains last month and the S&P GSCI reached its highest point since August 2008. Commodities beat stocks, bonds and the dollar for the five-month period through April, the longest stretch in at least 14 years, on forecasts that demand would exceed output in everything from copper to corn to oil. The most influential analysts and fund managers are divided on where prices are headed. The last time the S&P GSCI fell this much, the index rebounded 12% the following week, and by the end of last month, it had more than doubled. Bulls contend that the expanding global economy, led by growth in China, India and Brazil, is boosting demand at a time when such producers as BHP Billiton Ltd., the largest mining company, and BP PLC, Europe's second-biggest oil producer, can't keep up. Selling would be “premature,” and the rally will resume, said Hussein Allidina, the head of commodities research at Morgan Stanley Smith Barney LLC, reiterating comments made before the rout. “The decline we are seeing is not being driven by any meaningful change in fundamentals,” he said.

'NOT A TURNING POINT'

“This is not a turning point,” said Kevin Norrish, a managing director at Barclays Capital, whose commodities research team is ranked by Bloomberg in the top three for copper and gold. “We'd expect to see a pretty good recovery from these levels before too long,” he said. Brent crude should rebound about 3% to $115 a barrel in coming weeks because violence in Northern Africa and the Middle East continues, said Christin Tuxen, an analyst at Danske Bank A/S, the most accurate oil forecaster tracked by Bloomberg over eight quarters. The fighting already has curbed supply from Libya and increased concern that it may spread to regional producers, including Saudi Arabia. JPMorgan Chase & Co. on May 6 raised its oil price forecasts for this year and next because it expects production to fall short of demand. Brent crude will average $120 this year and 2012, from previous estimates of $110 and $114, respectively, the bank said. Oil prices should match or top their recent highs by next year, Goldman said in a note to clients on the same day.

GLOBAL RECESSION

The bears hold that even if the economy grows, speculation is so excessive that prices no longer reflect supply and demand. The S&P GSCI index still is 36% higher than a year ago and more than twice where it was in February 2009, when economies were recovering from the global recession. Commodities are at the start of a bear market that may last as long as five to 10 years, said Michael Aronstein, the president of Marketfield Asset Management LLC, who correctly predicted the 2008 slump that drove the benchmark index down 66% in seven months.

LIKE THE TECH BUBBLE

The scale of investment means “supply and demand is almost meaningless,” he said. “It's almost like the last days of the tech bubble.” Oil, which lost 15% two weeks ago in New York and 13% in London, has become “detached from fundamentals,” said Oswald Clint, head oil analyst at Sanford C. Bernstein & Co. Inc., which is tied for first for accuracy among the oil forecasters tracked by Bloomberg last year. Brent could drop below $100 a barrel, about 11% lower than now, he said. About $9.61 billion went into commodities funds in the first quarter, more than triple the $2.77 billion a year earlier, EPFR Global, a research firm, wrote in a report last month. Energy funds attracted $10.9 billion, compared with a year-earlier outflow of $367 million. A rebound in the dollar also dimmed the appeal for commodities that are priced in the U.S. currency. The U.S. Dollar Index, a measure against six counterparts, rose 2.6% two weeks ago, the most since August. The index has a negative correlation of 0.89 to the S&P GSCI. A figure of 1 would mean they were moving in lock step. The currency gauge may drop to the lowest since July 2008 by the end of the year, estimates compiled by Bloomberg show. “This is probably the beginning of a bear phase, even if it's temporary, where the dollar and bonds will be more popular than commodities,” said Chris Rupkey, chief financial economist at The Bank of Tokyo-Mitsubishi UFJ Ltd. “It's fitting hand-in-glove with the U.S. slowdown story.” The S&P GSCI's five-day slump, the longest since August, began May 2 and accelerated May 5 by plunging 6.5%, the most since January 2009. Silver led the rout after CME Group Inc., the owner of the Comex exchange, increased the cost of making new speculative positions by 84% in two weeks. Prices that had advanced as much as 61% to $49.85 an ounce this year tumbled 27% two weeks ago to $35.29 on May 6. The metal may drop as low as $30 toward the end of the year before rebounding as gold rallies, said Dan Smith, an analyst at Standard Chartered PLC, which predicted a decline in prices last month.

GOLD, SOROS

Gold also fell, declining 4.2% to $1,491.60 an ounce two weeks ago, after The Wall Street Journal reported May 4 that Soros Fund Management LLC, the hedge fund whose chairman is billionaire investor George Soros, sold some of its precious-metal holdings. Bullion will advance to a record $1,650 by year-end, partly fueled by central banks' buying to diversify their reserves, said Andrew Kaleel, chief executive of H3 Global Advisors Pty. Ltd., which has a commodities hedge fund that manages about $642 million. Mexico, Russia and Thailand bought about a combined $6 billion of bullion in February and March, International Monetary Fund data show. Since the end of 2009, countries such as Bangladesh, India, Mauritius and Sri Lanka have bought metal. Central banks are expanding their gold reserves for the first time in a generation, while bullion is rising for an 11th consecutive year, the longest winning streak since at least 1920. The killing of al-Qaeda leader Osama bin Laden may have been the catalyst for last week's slide in oil, the biggest exchange-traded commodity by value. Crude had surged as much as 25% this year as violence has swept through Northern Africa and the Middle East, disrupting 1.3 million barrels a day from Libya and raising concerns of shortages from the Persian Gulf.

FOCUS SHIFTS

Since bin Laden's death was announced, traders have shifted their focus to prospects of weaker demand. Service industries in the United States expanded last month at the slowest pace in eight months, the Institute for Supply Management said May 4. Applications for jobless benefits jumped the most since August in the week ended April 30, the Labor Department said May 5. That was tempered by a report from the department a day later showing that payrolls increased last month by the most since May 2010. Factory orders in Germany, Europe's largest economy, unexpectedly dropped 4% in March, the Economy Ministry said May 5. The country's industrial production rose for a third time the same month, the ministry said the next day. Central bankers also helped drive commodities lower last week by indicating their intention to cool growth to combat inflation. Rates rose in more than two dozen countries this year, according to data compiled by Bloomberg.

'EXTREMELY ALERT'

European Central Bank President Jean-Claude Trichet said May 6 that policymakers are “extremely alert” about inflation after they raised interest rates April 7, joining China, India, Poland and Sweden in seeking to control consumer prices with tighter monetary policy. He said that he may make further decisions on rates after new economic projections next month. Although every commodity tracked by the S&P GSCI fell last week, some rebounded May 6. Wheat futures rose 2% on the Kansas City Board of Trade as flooding and drought threatened crops in Asia, Europe and North America. Cattle, cocoa, copper, gold, nickel, soybeans and zinc also gained. Lower prices also may spur more demand. Barclays PLC, which told investors in a report May 6 to use the slump to buy, is forecasting shortfalls in production this year for copper, lead, nickel, palladium, platinum and tin. Rabobank Group expects demand to exceed output in corn and cotton, according to a report last month.

'STRONG' DEMAND

“Ultimately, supply remains weak, and demand remains strong, and that's why they will eventually go higher,” said John Stephenson, who helps manage $2.6 billion at First Asset Investment Management Inc. “Commodities, in the worst case, will start firming by late August, but in the meantime, I would see this as a buying opportunity.” Oil demand will exceed supply this year, the Energy Department said in a report April 12. Billionaire hedge fund manager T. Boone Pickens said May 3 that prices will rise. “If you look at the fourth-quarter projection for oil, that's 90 million barrels a day globally, and I don't think the world can produce more than 88 million,” he said. For now, funds are probably still trimming bets on higher commodities prices. Net-long positions held by managed-money funds fell 2.4% to 1.45 million futures and options in the week ended May 3, Commodity Futures Trading Commission data show. They reached a record 1.56 million contracts in October. Open interest in 17 of 19 commodities tracked by the Thomson Reuters/Jefferies CRB Index dropped 0.6% to 8.15 million contracts, data from the CFTC show. That compares with an all-time high of 8.6 million Feb. 18. “I don't think the commodities boom is over,” said Robbert Van Batenburg, an analyst at Louis Capital Markets, who predicted a 2007 rebound in oil. “We may see a pause in the rally, and that's OK,” he said. “Past the summer doldrums, I think the rally picks up where we left off.”