Update- The article below was written in December 2010 prior to peaking of most commodities in the first quarter of 2011 (see TABLE below). Despite market volatility and investment bank soothsayer spin, the article hasn't dated. Prices, of course are different from those below, but the story is the same. Beware! These relatively illiquid markets are dangerous.

Commodity price cycle has already peaked

By Neil Behrmann

 

December 2010 :- The big global market surprise in the coming year could well be a commodity price crash. Investors and speculators have built up a massive stockpile of oil, gold, silver, platinum, copper, aluminium and food ranging from wheat, corn, soybeans and rice to coffee, cocoa and sugar. They have been doing very well on paper. But a profit isn't a profit until it is

realised and at some point, the holders of the enormous global inventories will have to sell. When that happens, prices would fall swiftly.  Examine the Chart & Table below

         Commodity price surge when freight trade depressed-Why?

 

Investment holdings mind boggling

Examine some of the statistics. Data from IndexUniverse, a specialist publication and research organisation that follows exchange traded securities including commodities, estimates that in the US, commodity ETFs currently have assets of $100 billion. Including Europe and Asia, global commodity ETF holdings are around $130 billion. The biggest proportion is in gold, silver and energy funds. Meanwhile, the US Commodity Futures Trading Commission estimates that net long 'investment' holdings in commodities on

US exchanges amounted to $187 billion at the end of October 2010 and rose further in 2011.
These figures alone indicate that commodity speculative and investment bulls currently own a whopping $317 billion in commodities.

Barclays Bank, one of the investment banks enthusiastic about commodities as an investment, surveyed institutions and about 75 per cent of respondents forecast inflows of $50 billion or more in 2011. The majority are bullish about prices. Several large pension funds in the US and Europe have disclosed that they have been investing more money in commodities. At the same time, individuals have been buying gold and silver bars in Switzerland and elsewhere and hoarding them. There is also reported speculation and hoarding of a variety of commodities in China, India and elsewhere. The

global investment and speculative stockpile is thus much bigger than $317 billion.

Flows may drive prices higher in short run, but surplusses growing


The flood of money into commodities may well drive prices higher in the short run, but for prices to keep rising, investors and speculators have to absorb growing surpluses. Physical demand from factories and businesses is insufficient to close the gap with growing supplies from producers who are cashing in from windfall prices. One example is theslump in jewellery demand for gold and other precious metals. Several metals dealers and analysts have detected large stockpiles of copper and aluminium in China and report that production is well in excess of demand. Global rice and wheat production exceeds world demand, according to the US Department of Agriculture, but cotton production has fallen. Supply and demand figures for agricultural products vary, but speculation and investment have distorted prices and there is an overhang of inventories. Some event at some future time may well dent bullish views about commodities, causing holders to take profits and exit via a narrow door.

Table shows that despite periodic rallies commodities have peaked

 

Commodity or index

Decade low 2000-2002

2006 to 2008 peak

2008 December crash low

Date of 2011 peak

2011 Peak price

%  decline from 2011 peak to Friday May 6

CRB Index

183

474

200

April

372

-  8

GSCI Index

180

900

300

May

770

-11

Silver

4

22

8.5

May

49.8

-31

Gold

250

1040

680

May

1585

-  7

Copper

1440

9,000

2750

February

10,200

-14

Aluminium

1325

3400

1300

March

2800

-  8

Tin

3500

25600

10000

April

33000

-23

Zinc

750

4600

1000

February

2650

-21

Lead

400

3900

850

April

2900

-23

Nickel

4250

52000

9000

February

29500

-18

Cotton

29

93

36

April

220

-34

Sugar

5

20

10

April

36

-43

Wheat

240

14.50

4.5

February

9.00

-16

Corn

185

785

300

April

785

-12

Soybeans

421

1650

775

February

1455

-10

Cocoa

850

3300

1900

March

3800

-20

Coffee

41

175

101

May

310

---

Crude oil WTI

17

147

35

May

115

-18

 

 

 

 

 

 

 

 

The key message of the table, compiled by Traderight CEO, Steven Spencer & Neil Behrmann, is that with the exception of gold, silver, copper, tin, cotton, sugar & coffee, the majority of commodities did not achieve their 2006 to 2008 highs, this year. The 2011 peak the CRB Index of energy, metals and agricultural commodities, was 21.5% below its mid 2008 peak. The table is a cautionary sign that “buy on dips” is currently a dangerous policy. Since most commodties have large surpluses and inventories, prices, which are still high, could fall a lot further.

Warning signals and knock-on impacts

A classic warning sign of a market at or near its peak is large-scale commodity dealer Glencore's hint that it will list its shares early next year. During the crisis of 2008 to 2009, Glencore was borrowing from banks, partly

to allay market fears that some of its counterparties would fail.
If any decline in raw material prices becomes a rout, there may well be plenty of casualties. The bulls who bought commodities at sky-high prices will, of course, be first on the list. Oil and gold may not have the liquidity of currencies, sovereign bonds and large capitalisation equities. Silver, platinum, copper, aluminium, other base metals, grains, coffee, cocoa and sugar are relatively illiquid. So when the time comes to sell, late-comers may struggle to get out. The slide would be steep and swift, causing nasty losses.
This has happened time and time again in the commodity markets. Banks which financed producers and peddled the commodity investment products to pension funds and other individuals could encounter severe losses. There would also be a knock-on impact on resource equities which would bring down indices of major stock markets. Later, when markets settle down at lower levels, businesses and consumers will benefit from the lower costs. World economic growth will be boosted. Russia, Australia and other commodity producers would be hit, but that would be after several windfall years.

Ultimately lower commodity prices will be good for global economy


For now, consumers and businesses struggling with the high costs of food and raw materials should not panic. Unless there is a major supply disruption from a weather disturbance or another war in the Middle East, there is a very good chance that the commodity price cycle is about to peak.

 

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