Rout rids commodities of speculative froth

Commodities prices steadied on Friday after brutal losses caused by worries over slowing global growth, but with very little change in market fundamentals, the rout was caused more by the removal of speculative froth than the end of an 8-year bull run.

Over the past week, some disappointing data and nebulous worries about Chinese growth and monetary policy have prompted some analysts to express concern over a possible decline in demand for commodities, and perhaps even an end to the bull run that started in 2002 and was briefly interrupted by the global financial crisis of 2008, before resuming in 2010.

The Reuters-Jefferies CRB index .CRB, a global benchmark for commodities prices, is on course for its biggest weekly fall since July 2008, after giving up about 8 percent so far this week. It dropped 4.9 percent on Thursday.

U.S. crude oil prices extended losses after closing below $100 per barrel for the first time since March.

Silver, which has been a catalyst for the broader commodity market selloff, extended losses after falling 10 percent on Thursday, its biggest one-day loss since October 2008.

"The recent data suggests a contraction in growth, but not a collapse," said Joel Crane, an analyst at Morgan Stanley in Sydney.

"Commodity prices have exceeded fundamental values, so a pullback is justified. Weakness in the second quarter was to be expected given the challenge faced by the world in the past two months -- major political unrest in many of world's oil producers and the most costly natural disaster in modern times," Crane said in a reference to Japan's devastating March 11 earthquake.

Growth In China Looks Solid

But growth in rest of Asia, particularly China, looks solid with the world's top consumer of commodities and second biggest oil importer seen growing at a robust annual figure of around 8 percent in the next five years.

That has created a disconnect between the situation in Asia's big consumers of commodities and the mood among traders in Europe and the United States, where the economic situation is far more precarious.

"Capitulation or correction? This is a correction. There is an anchor for commodities -- the China growth story. That hasn't gone away -- nothing has changed fundamentally," said ANZ senior commodity analyst Mark Pervan.

"Investors had priced in a lot of good news, may be too much, and this week they have rushed for the door.

"There was already a good deal of speculative money flushed out in the past few days, but this is a good thing. Chinese consumers will find prices far more attractive and we may start to see appetite for imported commodities pick up."

That view was supported by Shanghai-traded metals which lagged their internationally traded counterparts, and by data on the Chinese economy showing that growth continued.

The price premium for the benchmark London Metal Exchange copper contract narrowed to 1,200 yuan versus its Shanghai equivalent from around 2,000 yuan when Shanghai closed on Thursday.

"This tells me that London was a bit frothy, while China was trading closer to fair value," said a trader based in Perth.

"The fact Shanghai hasn't collapsed under the weight of selling on international markets should be seen a positive for the state of demand and the real price for industrial raw materials."

China's official purchasing managers' index fell to 52.9 in April from 53.4 in March, well shy of market forecasts for an increase to 54.0.

But some said the pessimism toward Chinese demand was overdone, with 26 straight months of expansion and economists polled by Reuters expecting growth at 9.5 percent in 2011 after last year's increase of 10.3 percent.

A halt to the weakness of the dollar, which hit its lowest in three years this week after a drop over the past 11 months, could be in sight. The end of a second round of quantitative easing by the Federal Reserve in June could be the first step away from the U.S. central bank's ultra-loose monetary policy.

A recovery in the greenback would make dollar-denominated assets like commodities cheaper for holders of currencies like the euro or the yen.

"The feeling has been growing that the dollar has done enough on the downside for the time being," a fund manager said on condition of anonymity.

He said commodity markets had traded sideways since mid-April had traded, with investors epitomized by Goldman Sachs saying it was time to take profits, while others argued that commodities were still tight and the dollar would remain weak.

"In the last two days the market has broken down quite decisively as the world has decided maybe the Goldman view was right."

Fears of inflation in China also contributed to the weaker mood in commodities. However central bank officials expect Chinese inflation to moderate in the second half.

Yu Yongding, now a director in the Chinese Academy of Social Sciences, a top government think tank, said that soaring global commodity costs were the main source of price pressures, and that the Chinese economy was growing solidly but not overheating.

"If we address cost-push inflation just with monetary tightening, it will reduce supply and it will make inflation worse, so we must be cautious," he said.

Chinese consumer price inflation hit 5.4 percent in the year to March, a 32-month high. The government has raised interest rates four times and also restructured bank lending in a bid to tamp down on price pressures. Many investors think the next tightening move could be just around the corner, but the nation may be reaching the end of tightening cycle.

"We are looking at one or possibly two more hikes by the end of the second quarter, at 25 basis points each," said Stephen Green, an economist at Standard Chartered.

"In the last cycle they stopped hiking rates three months before the CPI peaked. CPI will be the best thing to settle market sentiment."

[Source: By Nick Trevethan, Reuters, Singapore, 06May11]

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