Why commodity prices collapsed2 min read . Updated: 08 May 2011, 09:41 PM IST
Why commodity prices collapsed
Why commodity prices collapsed
So what spooked commodity prices last week? The Reuters/Jefferies CRB index fell from a close of 370.5 on 29 April to 337.35 on 6 May, plunging 9.8%.
Analysts have pointed to leading commodity producer and marketer Glencore International AG’s $11 billion monster initial public offering as marking the top of the commodities market, just as private equity group Blackstone’s float came at the top of the debt bubble in 2007.
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Goldman Sachs Group Inc. had warned investors in mid-April to get out of commodities, because they had become too pricey. Among a lot of other things, the brokerage said, “We maintain that crude oil prices have pushed ahead of where fundamentals currently suggest, and that the near-term downside risk to prices has risen in recent weeks as oil prices have climbed to exceptionally high levels."
Some point to the close correlation between the commodity collapse and the strength of the US dollar. That, in turn, was due primarily to a diving euro, the result of the European Central Bank holding its fire and another scare from Greece. The dollar index shot up from 73 on 4 May to 74.8 on 6 May. And commodities move inversely to the dollar.
But then, there have been similar sharp falls in the commodity index in November 2010 and March 2011. Could this time be different? Goldman Sachs says no, it isn’t. It’s just a pull back in a long-term commodity bull market. And one obvious difference is that commodity prices are higher than during the previous episodes.
But here’s one reason why there could be a fundamental reason for commodities tanking: the global economy is at its weakest in months. The JP Morgan Global Manufacturing and Services Purchasing Managers’ index for April shows growth has weakened significantly and the world economy is expanding at its slowest pace since the recovery began in 2009.
Critical for commodity prices is the performance of the manufacturing sector. The JP Morgan Global manufacturing PMI was at a five-month low in April, with slower growth seen in the US, the UK and China. The HSBC China Manufacturing PMI showed that growth slowed to a nine-month low in April, and commodities, of course, catch the flu when the Chinese economy sneezes.
To put the slowdown in perspective, however, David Hensley, director of global economics coordination at JP Morgan, points out that growth in global manufacturing is still above its long-run average. That doesn’t suggest any continuing sell-off in commodity prices. And the International Monetary Fund has said that despite the risks, global recovery will gain strength.
The other factor is that excess liquidity continues to bubble in and out of asset classes and commodities are no exception. In fact, the April Bank of America Merrill Lynch survey of fund managers last month showed a net 40% overweight in the energy sector. This survey has served as a strong contrarian indicator and the crash in crude prices strengthens that track record.
The net result: redemptions from commodity funds hit a weekly record, and over $1 billion was pulled out from energy funds in the week to 4 May, according to fund tracker EPFR Global.
The combination of red-hot price action and slowing growth ultimately proved unsustainable.
Graphic by Yogesh Kumar/Mint
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