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DJ MONEY TALKS: Commodities Stumble As Headwinds Mount In 2010

Feb 08, 2010

By James Campbell

A Dow Jones Newswires Column

SINGAPORE (Dow Jones)--In a conference call with clients last week, Barclays Capital said commodities had a "shaky" start to the year. That's putting it mildly, with volatile price swings in industrial inputs like copper and oil as well as precious metals--and all with a broadly downward bias.

The mood is similar to this time last year, when stock markets had yet to bottom, the recovery theme was not yet in vogue and cash was king, elevating the U.S. dollar. Commodities don't do well when the dollar is riding high.

So what's the difference between now and early 2009, when we then embarked on a nine-month commodities rally?

First and most obviously, prices are much higher--many commodities finished 2009 with triple digit percentage gains and are trading well above the cost of production, which immediately implies some downside risk.

Secondly, the political jawboning about financial markets is reaching a crescendo and commodities are directly in the firing line. Only last week U.S. Senator Maria Cantwell renewed her call for the U.S. Commodity Futures Trading Commission to crack down on "excessive speculation" to reduce volatility. Traders do not like the kind of uncertainty that political interference creates and anything that hurts U.S. markets and investors will not leave the rest of the world unscathed.

Thirdly, while China's thirst for commodities has not been slaked, growth rates in consumption and imports will not match last year with a bigger base effect in play to make the headlines much less dramatic. China's supply chain is also better stocked, especially for copper, zinc and nickel, although some domestic-focused industries like automobiles are growing at a very fast rate.

And one factor that hasn't changed from this time last year: OECD commodities demand is still bumping along the bottom. The restocking effect that many of the more bullish analysts are relying on to justify higher price forecasts is not yet apparent with key consuming industries like construction still in a funk.

Lastly, in early 2009 the post-financial crisis U.S. dollar rally was running out of steam. This time the dollar is only just edging higher with the euro the currency on the ropes. Whatever the long-term outlook, if the dollar does go into a sustained counter-trend rally then all bets are off. Not only will it push up nominal commodity prices in other currencies, it will see a further unwinding of the dollar carry trade, the cheap funding that has driven much of the investment interest in the sector.

A renewal of the commodities rally will require monetary tightening to stay off the table to hold the dollar in check, OECD demand to improve, and politicians to cease their grandstanding, otherwise January's volatility and weakness could be the story for the year.

(James Campbell is a commodities reporter at Dow Jones Newswires in Singapore specializing in metals. He has five years of experience as a journalist and editor and can be contacted on 65-64154082 or by email: james.campbell@dowjones.com)