Despite the turmoil in Europe and the prospect of slowing growth in emerging markets, commodity prices have remained high. The Thomson Reuters/Jefferies CRB Commodity index, although has fallen from the highs it reached earlier this year, is still higher than what it was a year ago.
And despite the slowdown in global manufacturing as evident from the Purchasing Managers’ indices of various countries, crude oil prices remain high. For instance, the price of Brent crude is higher than it was at the beginning of the year, or indeed, for some time during June-July.
A United Nations Conference on Trade and Development report on Price Formation in Financialized Commodity Markets had said that despite the big decline in global industrial output after such a severe financial crisis, commodity prices have been doing well compared with earlier business cycles. It said there was a close correlation between changes in oil prices and in money managers’ positions since mid-2009. In short, it said that commodity prices may deviate from the fundamentals as a result of commodities having become just another asset class for investors.
HDFC Securities Ltd has now come out with a report that examines the effect of financialization on commodity prices. The report points out that commodity assets under management (AUMs) have been growing disproportionately—they’ve moved up from 0.27% of global gross domestic product in 2008 to 0.65%. After an exhaustive analysis of fund flows into commodities and commodity prices, they conclude: “We...note the increasing flow of funds (AUMs) into the commodity sector—from a meagre $10 billion in CY01 (2001) to approximately $400 billion in CY11E. Of the total commodity AUMs, we note that 1) average 40% flow into the base metal space, 2) copper attracts approximately 50% of the base metal AUMs followed by aluminium at approximately 30%. We analyse the contribution levels of fundamental factors and fund flows on metal pricing and note 1) fundamental aspect (we represent it through stock consumption ratios) explains less than 20% of pricing, 2) fund flows explain an average of 60-65% of metal pricing.”
Also See | It’s Financialization (PDF)
This is exactly what Reserve Bank of India governor D. Subbarao had said. He had pointed out in one of his speeches in September that “the negative outlook on growth should have driven down prices, but that has not been evident so far to any significant extent”.
With no alternative to loose monetary policy in the crisis-ridden advanced economies, commodity prices are, therefore, likely to remain well supported. Taken together with the rupee depreciation, the high commodity prices will continue to pose an upside risk to inflation in India.
There is, however, a silver lining; last month’s Bank of America-Merrill Lynch survey of global fund managers found that a net 7% of investment managers were underweight on commodities, compared with an overweight of 4% in September.
Graphic by Sandeep Bhatnagar/Mint
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