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Commodity Monthly

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It's the economy, stupid!

Fri, Sep 5 2008, 15:32 GMT
by Arne Lohmann Rasmussen

Danske Bank A/S

Weak economies can bring down presidents, and can certainly bring down commodity prices. The commodity market has, broadly speaking, experienced a six-year-long boom driven by supply disruptions and galloping demand. Hence, the past couple of months have been a rude awakening for the market. Oil prices have collapsed by close to USD 40 from the peak and major base metals like copper and aluminium have seen their 2008 gains more or less erased in two months. Many commentators have pointed to speculators as the reason for the initial boom and subsequent decline in commodity prices this year. As we wrote in our July edition, we think speculative activity was a contributing factor to pushing oil prices above USD 145 a barrel and was the reason why aluminium rose strongly in July. Hence, subsequent profit-taking and squaring out of long positions might have contributed to lower prices. But we think the 'blame it on the speculators' approach is too simplistic. Oil prices and other commodities actually rose in the spring due to several signs of a market tightening very quickly despite obvious weakness in the US economy. However, over the summer, it became clear that the weakness in the US economy could not be contained in the US. The widespread belief that the rest of the global economy would power ahead fuelled by Asian demand and 'de-couple' from the US was wrong. Over the past couple of months we have seen a series of weak numbers from Europe and Asia. There are growing signs that fixed asset investments are slowing down in China, and in Europe even the last man standing Germany is showing clear signs of weakness. Commodities are simply under pressure due to a more bleak global growth outlook. We are not out of the woods yet with regards to global growth and the pressure on commodity prices might very well continue for a while.

However, from a forecast view, the question is whether enough weakness is now priced into commodities. Our view is that some of the 'automatic stabilisers' should start to work. OPEC might slash oil production next week; aluminium, zinc and nickel prices are trading close to marginal costs; and the dollar strength should start to slow down. Copper supply is still struggling to keep up with demand. Hence, we maintain our medium-term positive view of the commodity market, but certainly recommend caution given the economic business cycle outlook. The correction could very well continue during September. We might also see more positioning for downside risk over the next couple of weeks. We have just seen the closure of a major commodity hedge fund which could lead to further liquidation of long commodity positions in the coming weeks.

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Published on  Fri, Sep 5 2008, 15:36 GMT