Commodities Plunge Most in Two Years on Slowdown Talk
Comment of the Day

May 05 2011

Commentary by David Fuller

Commodities Plunge Most in Two Years on Slowdown Talk

This is certainly today's main story and here is the opening from Bloomberg's summary:
Commodities dropped the most in almost two years, paring this year's gains to 10 percent, on speculation that economic growth will slow as central banks seek to cool inflation by raising borrowing costs.

The Standard & Poor's GSCI Index of 24 raw materials fell as much as 5.9 percent to 688.25, the biggest drop since June 22, 2009, and was at 697.44 by 5:30 p.m. in London. The gauge has dropped 9.3 percent from a two-year high on April 11. Silver, crude oil and heating oil led the declines.

The European Central Bank President Jean-Claude Trichet said today the bank will monitor inflation risks "very closely," suggesting it may wait until after June to raise interest rates again. The ECB raised interest rates on April 7, joining China, India, Poland and Sweden in seeking to control inflation. The cost of living in the U.S. rose at its fastest pace since December 2009 in the year ended in March, the same month when Chinese consumer prices rose by the most since 2008.

"This could be one of the most severe corrections that we've seen over the last year," Sean Corrigan, chief investment strategist at Diapason Commodities Management SA, which has about $9 billion invested in commodities, said by phone from Lausanne, Switzerland. "If things get really bad, we could possibly retrace half of the rally of the past six to nine months."
Glencore Offering

The slump in raw materials comes as Glencore International AG sells shares in an initial public offering which may value the Baar, Switzerland-based commodity trader at about $61 billion. Goldman Sachs Group Inc. in reports on April 11 and 15 told investors they should be "underweight" commodities in the next three to six months. The bank still expects commodities to advance about 10 percent over the next 12 months.

Crude oil fell 6.3 percent to $102.36 a barrel in New York trading, while Brent oil retreated 6.1 percent to $113.82 a barrel in London. Gasoline declined 4.5 percent to $3.1751 a gallon on the New York Mercantile Exchange and natural gas fell 5.3 percent to $4.334 for a million British thermal units.

"The market is clearly vulnerable," Corrigan said, adding that West Texas Intermediate crude may decline to $100 a barrel, and copper may drop to $8,000 a ton if selling picks up. "Gold would be the least of your worries, it's going to be the industrial cyclical commodities, it's going to be the coppers and the tins and the crudes that get hit the worst."

David Fuller's view Prior to today, I have pointed out the Continuous Commodity Index's (Old CRB's) vulnerability on four occasions within the last two months, pointing out its overextension relative to the rising 200-day moving average, the weekly key reversal in March and also yesterday's fall from the high. This move (weekly & daily) has been extended today and my minimum downside expectation would be for test of the MA, currently just over 600, as is the January 2008 peak.

However t he Old CRB is very likely to fall beneath those levels, for both technical and fundamental reasons, but I view this move as a significant medium-term correction within an ongoing secular bull market for resources.

Reasons for the correction are numerous. Prices for many commodities, from food to energy, had reached punishing levels for both individual and commercial consumers. Crude oil's moderate spike (Brent & WTI) had already reduced global GDP growth prospects, as I have mentioned on many occasions. An orgy of commodity speculation has occurred, from positions in iShares, ETFs and other trackers, to hedge fund and individual trading. Industrial consumers of commodities, from China to individual companies had shifted from 'just in time' inventories to stockpiling. Central banks in growth economies have been ratcheting up interest rates in an effort to curb commodity price inflation. Commodity exchanges have hiked some margin requirements, not least for silver. As I recall, the CFTC will be commenting on large positions in some staple commodities which were never intended to be buy-and-hold investments, as I have mentioned before. The US Dollar Index (weekly & daily) is ripe for a short-covering bounce.

Against this background, I would not assume that gold or any other popular monetary commodity is immune to the selling pressure, as we have seen again today. It all depends on how many highly leverage players are being squeezed. Moreover, some of those who understand market dynamics are exiting, just in case self-feeding liquidation creates an overshoot, as it easily could. This is not 2008 all over again but it is a significant correction. The cure for high prices remains high prices.

This rout in overextended commodity trends is good news for stock markets and the global economy but we are unlikely to see the benefits for several months. First, investors have to discount slower GDP growth and lower corporate profits caused by the spike in crude oil and other commodities. Central banks will want to cap inflationary pressures, at least until slower growth and unemployment become the main concerns once again.

Obviously these priorities vary considerably, in line with GDP growth rates and reported inflationary pressures. For instance, China and India will sacrifice some of their strong growth in the effort to reduce inflation. Conversely, the USA is more concerned about unemployment and evidence that the modest economic recovery is slowing. As events play out we should remember that China-led growth economies are the locomotive, not the USA, although it remains by far the biggest passenger car in the train.

As the dust begins to settle following the commodity and stock market shakeout, we will have another buying opportunity. The demand for resources will be high and supply will not always be able to keep up. Equities will offer improved valuations and scope for corporate profits and dividend increases, not least among Fullermoney secular themes.

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