Commodity rally may not augur rapid recovery

Reuters | Thu, 11 Jun 2009 20:52
[miningmx.com] -- The commodity market rally is being seen as a sign of imminent economic recovery, but that could be an extrapolation too far as higher prices may be more to do with fund allocations and anticipation of revival.

The meltdown in the banking sector and economic recession triggered a sell-off of stocks and industrial commodities such as oil and copper and investors have opted for safer assets such as cash and gold.

Institutional investors normally have benchmark or neutral allocations to equities, bonds, alternatives such as commodities and hedge funds and cash. Most have been overweight cash and are now moving their portfolios back to neutral.

"Some people are definitely putting the cart before the horse. They see higher oil and copper prices and think it must mean recovery," said Adam Robinson, director of commodities at fund manager Armored Wolf.

Many natural resources focused hedge funds with most or all of their assets in cash over the last six months have also added to the billions of dollars heading for commodity markets.

Signs the global economy may be bottoming, after the slump in the last quarter of 2008 and the first quarter of 2009, have also persuaded investors to plough money back into the sector.

"A small reallocation from less risky assets like cash into commodities has led to a large rise in prices," said Eugen Weinberg, commodities analyst at Commerzbank.

"Chances are good that buyers of the recovery story will be disappointed because economic data is pointing to a slowdown of the slowdown, pricing in recovery is premature," Weinberg said.

COMMODITIES EARLY CYCLE PLAY

Interest rates near zero are also an incentive for investors to try and make their money work harder elsewhere.

"You can't earn anything in cash ... The (U.S. Federal Reserve) with zero interest rates is effectively trying to get people to put their money back into markets," Robinson said.

Part of the reason for investors returning to the commodities sector is capacity, which is expected to fall well short of demand over coming years.

The credit freeze meant access to financing for new, sometimes existing, projects was no longer available or affordable and many producers had to abandon spending plans.

Prices of copper used extensively in power and construction have nearly doubled to 8-month highs of $5,300 a tonne since 4-year lows of $2,825 last December.

Crude oil also collapsed to 5-year lows near $30 a barrel last December, before recovering to $72 a barrel on Thursday. Investors say signs of supply shortages as illustrated by the number of oil rigs are already being seen.

The number of drilling rigs globally is estimated by analysts to have fallen by more than 30 percent to near 2,000 in 12 months to April.

The potential for high deficits in commodities such as oil and industrial metals is why many still believe in the commodities supercycle. They do not want to miss profit opportunities in the way they did five years ago.

"Normally commodities tend to be late cycle plays," said Ashok Shah, chief investment officer at London & Capital.

"This time round commodities have become an early cycle play because miners and oil producers during the last cycle did not create as much capacity as was needed."