Commodity price cycle getting ready to peak

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.

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.
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.

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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