Another commodity boom that isn't


By Neil Behrmann

April, 2009:-  IT IS happening again. Following an extraordinary boom and slump, commodities are being hyped as investments again.

Sales people are trying to persuade unwitting investors to purchase these 'real assets' to hedge against non-existent inflation.

Some are even making ludicrous claims that China may place its multi-trillion foreign exchange reserves on a 'copper standard'. Gold, with its long-standing monetary history, is understandable, but the replacement of the US dollar with a base metal that trades in an illiquid market, beggars belief.

Regulators & Central bankers again out of touch

It has become increasingly urgent that global regulators and central banks investigate the 'investment flows' that are distorting commodity markets.

Indeed central bankers, displaying abysmal ignorance about commodity trading, wrongly believed that fundamental, rather than speculative, forces caused prices to soar in 2007 and 2008. Fearing inflation, monetary policy, especially in Europe, was kept tight for far too long, contributing to the severe credit crunch in the fourth quarter of last year.

Unfortunately, there are worrying signs that regulators and central bankers are again blissfully ignoring events in the commodity markets, on the assumption that they are insignificant relative to financial and currency turbulence.

They are wrong. Firstly a prolonged, speculative induced raw materials price rally could re-ignite inflation, forcing central banks to put on the brakes prematurely.

Secondly, another commodity bust, following the rally, could wreak considerable damage on large and small indebted mining and other resource companies and the banks and bond-holders that have financed them.

Harry Markopolis was ignored a few years back when he warned that Bernie Madoff was a fraudster. At a recent US Congress hearing, he castigated staff at the Securities Exchange Commission. Similarly, whistle-blowers such as David Threlkeld of Resolved Inc have been sidelined in the metals markets.

BIS Statistics worrying

For those who believe that commodities are a sideshow, examine the latest statistics of the Bank of International Settlements: Total open interest or contracts outstanding on global commodities exchanges rose to 39.5 million in December 2008 from 36.5 million in 2006. In 2008 turnover of contracts amounted to 1.7 billion. On the Over The Counter Market, the notional value of commodity derivatives climbed to US$13.2 trillion at the end of June 2008 (the peak of the market) from US$6.4 trillion in June 2006.

The marketing mantra of the commodity 'investment' industry is that demand from China is surging again and that the nation is stockpiling hundreds of thousands of tonnes of metals and other raw materials to make the nation less dependent on foreign suppliers.

Indeed China is stockpiling; but it has already done much of it at much lower prices and is not chasing the market. According to metals traders and China watchers such as Simon Hunt Strategic Services, the bulk of metals that are being imported are landing in stockpiles of speculators. They are lying in warehouses on hopes that industries will eventually buy them.

The other mantra is that Western economies are sprouting green shoots and as they grow, inflation will soon follow. 'Producers have been cutting production in the downturn, so buy commodities now to protect yourselves,' say brokers, fund managers and investment advisers who are persuading pension fund managers, wealthy and not-so-wealthy investors to place money in a variety of commodity index and mutual funds.

After all, the CRB index at 384 points is 'good value' compared with the June 2008 bubble peak of 620 points, they claim. The chart, however, cautions that they are still much higher than levels a few years ago. And then economic conditions were far better.

Fundamentals poor and manipulation alleged

Even if the most optimistic economists were correct and the global economy bounced back tomorrow, the business cycle revival normally starts with consumer demand and corporate investment and finally an upturn in purchases of industrial raw materials. The commodity sales people are ignoring cyclical history and are placing the engine behind the train coaches to justify purchases.

Production of the majority of commodities, including oil, are well in excess of consumption and there are sizeable inventories.

Indeed, some participants in the copper market are alleging, for example, that several producers are colluding with banks to support the market by purchasing and secretly stockpiling copper, the bellwether of metals. According to analysts and traders, the monthly surplus of copper supply over industry demand is running is 200,000 to 250,000 tonnes and that metal has to be deposited somewhere.

So far, the bulls are in the ascendancy. They have blown the copper bears out of the water. The price, which soared from $1,200 a metric tonne (54 cents a pound) in 2002 to almost $9,000 (408 cents) mid-2008, plunged to $2,700 (122 cents) in December last year.  It then jumped to a 2009 peak of almost $5,000 a tonne (226 cents)in the past week before falling back to around $4600 (208 cents a pound).

Concerns about ETFs and other commodity investment products

Can producers and other sellers keep the bullish momentum going? The hope of the bulls is that investors will absorb the glut of commodities in the market. Some 200 exchange-traded products that track commodity prices, notably exchange-traded funds (ETFs), exchange-traded notes (ETNs), and exchange-traded commodities (ETCs), have investor money of $64 billion, according to Barclays Bank. Steven Spencer of Traderight, a UK commodity trading advisor warns that investors should scrutinise these products.  During times of commodity gluts, futures prices stand at a "contango" or premium over spot prices.  The ETFs with few exceptions (e.g. StreetTracks GLD) track the futures prices. Other things being equal, as the months go buy, futures quotes fall back to the spot or cash levels. Prices thus need to rise swiftly, if not, investors will soon be in the red.  The commodity collateral, or backing of these products, should also be checked.  They are quoted on stock markets so the SEC and other stock market regulators shouild monitor them.

Traditional commodity index products sold to pensions amount to another $60 billion and commodity mutual funds manage about $34 billion. These products, with few exceptions, track commodity derivatives.

Over and above these 'long only' bullish funds controlling some $150 billion managed futures and hedge funds, and other speculators play with several hundred billions. The big difference is that they trade the market and sell short from time to time, aiming at profiting from a downturn.

Indeed many of these funds precipitated the rally in commodities as they were forced to cover bear positions.

It is thus not difficult to gauge that these massive investment and speculative flows, following the momentum of prices up and down, can create considerable distortions in the market. Regulators and central banks should not ignore the dangers again.


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