Commodity dive is a correction not a complete collapse

Philip Salter
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DESPITE last week’s precipitous fall in commodities, not all fell equally and not all will stay low. Excepting the case of silver, this wasn’t the sound of bubbles popping. As such, investors and traders should not exit the whole asset class. Sentiment has certainly shifted, but the fundamentals behind the price and prospect of each commodity need to be looked at on a case by case basis to decide how to trade.

Thursday saw the heaviest fall in commodities over one day since the financial crisis. Silver plunged 12 per cent on Thursday and slid further on Friday, falling close to 30 per cent over the week. Oil also took a tumble, as did gas, copper, aluminium, tin, and gold. Coffee, corn, cotton, sugar, soyabeans, and cocoa were also down. In fact, on Thursday all commodities fell. By Friday, outflows were apparently stemmed, though late-breaking euro fears took out some earlier gains.

Alastair McCaig of WorldSpreads posits that there were four principal reasons for the commodities crash: an apparent slowdown in the US; Trichet’s comment that he is extremely alert on inflation; a global calm down – excluding Syria – in instability; and a cool down in China’s growth. Additionally, rumours, yet to be confirmed or denied, had been circulating that George Soros has moved out of precious metals – encouraging a herd mentality. Goldman Sachs also contributed to the movement in commodity markets, advising investors to sell commodities.

Michael Hewson of CMC Markets is still bullish on gold. Its climb has been a lot steadier than silver’s parabolic rise, so he sees no reason to be concerned unless it drops below $1,300. Silver could correct further – after all, it was at $17 only twelve months ago. Hewson thinks that with a slowdown in emerging markets, whose governments are prepared to suffer a decline in short-term growth to tackle inflation, silver, as an industrial as well as precious metal, will likely suffer more than gold.

McCaig says that he would need to see more evidence before calling this a bursting of the commodities bubble, rather than just a natural market correction. Also, it should be noted that even though Goldman Sachs called investors to sell its CCCP basket of crude oil, copper, cotton, soyabean and platinum, to take the 25.3 per cent profit they have seen in the last four months, the note released by Goldman’s commodity team stated that they “believe that on a 12-month horizon the CCCP basket still has upside potential.” Ian O’Sullivan of Spread Co thinks things could look different next week: “Following a sell-off like this, the weak prices could attract fund buying and help boost commodity prices. We could also see some gains next week if importers try to take advantage of these relatively low prices.”

At the end of last week, the herd decided that to a greater or lesser extent all commodities are overvalued. In the case of silver, a bubble has undoubtedly been popped, but the indiscriminate nature of the sell off suggests an overreaction – and thus that a few bargains may be available.

Silver’s aggressive rise precipitated an equally dramatic fall. Ian O’Sullivan of Spread Co believes that its fall has not been entirely unexpected. “The climb to almost $50 in silver has been out of control and anyone trying to pick a top up to Monday were feeling a lot of pain on the way up.” According to Angus Campbell of London Capital Group: “The recent moves in silver indicate just how much speculative froth was in the price and with the increase in margin requirements enforced by the CME it’s difficult to see the metal return to test its all time highs any time soon.”

Alastair McCaig says gold has had a decade of bullishness, so its recent pull back cannot be compared with that of silver. Angus Campbell of London Capital Group says gold “has not suffered quite so much from the recent commodity sell off when compared to silver.” This he says “indicates that the allure of gold places it as a favourite above other metals. Even though it has no industrial purpose, it is still considered a safe haven investment and the main beneficiary of a weaker dollar. The dip below $1,500 is being seen as a buying opportunity by clients who continue to remain staunch bulls of gold.”

Last Wednesday, futures in Arabica coffee fell from their 34-year high. However, the recent commodity correction hasn’t dented the price a great deal yet. Angus Campbell of London Capital Group believes that although the recent correction in commodity prices has not impacted coffee very much, stockpiles are growing, thus keeping prices in check for now. Exporters have also been ramping up production, so he says “with more coffee around, further rises might be hard to come by.” In the past, coffee has had a number of crashes, so the wind might be about to change on this commodity.

With the UN predicting that the seven billionth person will be born this year, Angus Campbell of London Capital Group thinks this boom “will continue to underpin the prices of many soft commodities like wheat, corn and soybean as not only are they used as renewable energy sources, but to feed the increasing number of mouths on our planet.” Although in the short-term these prices have seen downside, the key issue will be the summer weather over the Midwest of North America. On this, Ian O'Sullivan of Spread Co says there are “reports of extremely dry weather in parts of America and China harming crop forecasts.”