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Friday, June 08, 2012 1:20:00 PM
08 June 2012, 12:51 p.m.
By Allen Sykora
Of Kitco News
http://www.kitco.com/
(Kitco News) - Commodities have come under heavy pressure since worries about Europe’s debt woes were heightened this spring and there may be more downside to come, analysts said.
Europe’s troubles are leading to fewer exports from China and thus contributing to a softer economic tone in the key commodity-consuming nation. Also, the European backdrop has left investors reluctant to hold so-called risk assets such as stocks and commodities.
The Continuous Commodity Index, a basket of 17 raw commodities, fell 27% from a record high of 691.09 in April to a 21-month low of 502.28 last week. Industrial commodities have been especially hard hit, with most-active July crude oil on the New York Mercantile Exchange falling 26% from a May 1 high of $106.77 to a June 4 low for the year of $81.21. London Metal Exchange copper slid 15% from an April 30 high of $8,496.75 a metric ton to a 2012 low of $7,233.25 on Friday. December cotton fell 28% from a late-April peak of 89.55 cents a pound on ICE Futures U.S. to a Monday low of 64.61.
European economic data has been weak as the continent deals with a debt crisis in periphery nations. Much of the focus has been on Greece, where elections on June 17 are seen by some see as a de-facto referendum on whether it stays in the eurozone. Spain’s fiscal problems have risen to the forefront, with banks in need of capitalization and ratings agencies downgrading the country’s debt. Spanish and Italian bond yields rose above 6% last month as investors were hesitant about taking on their debt.
“We’re going to continue to see these problems down the road,” said Bart Melek, head of commodity strategy, rates and foreign exchange with TD Securities. European officials will face challenges reaching political solutions, particularly with the German public largely opposed to bailouts, he said. The uncertainty has left commodities under pressure despite a surprise cut in Chinese interest rates Thursday meant to prop up the economy.
“In spite of the fact the Chinese have now eased more aggressively than had been expected, we still see a bit of downside in the commodity space,” Melek said. “China will probably continue to show relatively poor (economic) numbers and of course Europe is a huge mess. So Chinese exports there (Europe) aren’t going to be increasing any time soon in a material way. And at the same time, we’ve got issues in the United States, where growth is performing less robustly than we would like.”
This means inventories of commodities in general will be higher than would have been the case if economic conditions were stronger, Melek said. In fact, he said, some stockpiled copper has been exported lately from China, the world’s largest buyer.
Bill O’Neill, one of the principals with LOGIC Advisors, said money flows are working against commodities without regard to supply/demand fundamentals. “There is not a lot of speculative money coming into commodities.”
He does not foresee the worries driving commodities lower ending any time soon.
“I do think commodities are getting oversold and markets are moving to levels weaker than their supply/demand equations may justify,” O’Neill said. “But until we get out of this risk-off mentality and period where funds are not making any kind of aggressive commitments to the markets—and even the trade is being cautious—we’re probably going to continue to see prices slide.”
For now, O’Neill said his own firm is taking a “stand-aside” view on nearly all commodities.
Spencer Patton, chief investment officer with Steel Vine Investments, said markets will be watching to see whether European officials agree on aid for Spain and develop a backstop to halt a run on bank deposits in some nations.
“Short of those two items, the pressure is going to continue through a weaker euro and stronger U.S. dollar,” Patton said. Market participants may use any short-term commodity bounces to lighten up on long positions, he said. “I’m not ready to buy until we get some confirmation that Spain is going to be in a better place.”
Patton doubts the euro has put in its low for the cycle. The currency hit a nearly two-year low of $1.2289 last Friday. A stronger dollar hurts commodities by making them more expensive in other currencies.
Analysts said they look for industrial commodities such as copper, aluminum, oil and platinum to be hit hardest by the European issues. Melek described copper as especially vulnerable since the price remains well above the cost of mining.
Gold may hold up better than most commodities due to its safe-haven status, Melek said. Patton looks for grains such as corn and soybeans—which tend to react to weather and harvest potential--to be among the better performers.
Commodities To Eventually Bounce If/When Europe Comes Up With Measures
Analysts eventually look for a pick-up in commodities, particularly if European authorities agree on measures to stabilize the continent’s financial picture.
“We see things improving materially in the latter part of the year,” Melek said. “We ultimately think the Federal Reserve helps out with stimulus, although not quite yet. We think they will wait until after elections. We are of the view that ultimately Europe will not allow the euro to fall apart. But from here to there, there is going to be a lot of volatility and the risk is to the downside in the short term.”
Patton and O’Neill also look for European officials to eventually cobble together a plan. “There is just too much on the line for Germany and everyone else to let the euro explode,” Patton said.
Adrian Day, president and chief executive officer of Adrian Day Asset Management, figures commodities will eventually find support since China’s economy continues to grow, albeit slower than in the past.
“If China’s economy continues to have real growth, whether 7% or 8%, that is still an increase in demand for commodities,” he said. “Unless China’s economy goes into a hard landing, and we’re a long ways from that at the moment,…the growth in China will more than offset the decline in Europe.”
By Allen Sykora of Kitco News; asykora@kitco.com
http://www.kitco.com/reports/KitcoNews20120608AS_Europe.html
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