The general improvement in sentiment in the financial markets over the past month has also been evident in the commodity markets.
There has been further evidence that the global economic recovery in continuing, there has been more support for the view that the pressures resulting from the sovereign debt crisis in Europe may be easing.
As a result, base metals are generally lower over the month, even after the rally on the latest Chinese announcement about the renminbi; most soft commodity prices are slightly lower, although there have been sharp rises in beverage prices on concerns about future supplies; precious metal prices have moved higher as investors have continued to seek “safe havens in the storm”; and there has been a strong recovery in oil prices, helped by optimistic signs of a pick up in US demand.
Base metal prices are ending the past month well above recent low levels, but still slightly lower overall, and there has been an additional boost to confidence in the announcement of a “more flexible” policy towards the renminbi.
It is assumed that even a modest appreciation of the Chinese currency will boost the purchasing power of Chinese buyers, and increase still further China’s position as the world’s largest importer of a broad range of global commodities.
But there is clearly a risk that the importance of this fairly modest move is being exaggerated; and the extent of the earlier reaction should be a powerful warning of the degree of speculative activity in the markets, and the vulnerability of prices. Chinese demand clearly remains a critical factor, and the evidence suggests that it will remain reasonably strong.
Soft commodity markets have again produced a more mixed performance.
Movements in grain prices have been fairly modest, although there has been some support from a recent report by the US Department of Agriculture that the increasing importance of ethanol production will continue to draw down stock levels and help to offset the effects of what is expected to be a bumper grain crop this year.
Most price movements elsewhere have been fairly small; but there have been two significant exceptions. Cocoa prices have been pushed to their highest levels for more than 30 years because of disappointing crop levels in West Africa, and particularly in the Ivory Coast, and the warning that the fall in production will continue unless there is significant investment in new trees and in fertilisers.
There are fears that demand will outstrip supply for the fifth successive year in the 2010/2011 season, and this has forced cocoa buyers to push up prices to cover their requirements, and has exposed the position of banks and others that sold call options in the expectation that prices would fall. The second significant exception has been coffee prices, which have increased by almost 20% during the past month.
The indications are that one commodity-trading house has accumulated a very large number of futures contracts and has indicated that it intends to take delivery of the coffee.
Other funds that had sold futures contracts short have been unable to obtain the coffee to honour those contracts, and so have been forced to scramble to close them and have suffered considerable losses as prices have moved higher.
It is not yet clear whether this technical position has now been cleared; but the fundamentals do not appear to justify the price action, since Brazilian production is expected to be very high in the current season, and so, once the technical position had been cleared, prices could fall fairly sharply.
Oil prices have also been affected by the improvement in market sentiment, and have recovered very sharply over the past month.
Speculative activity has been an important factor; but there has also been an encouraging report from the US Department of Energy indicating strong demand for oil products in the US, and a larger-than-expected reduction in crude oil inventories.
There has also been evidence of continuing strong demand from China; and a warning of the onset of the hurricane season in the Gulf of Mexico, and its possible effects on production levels.
So far however the dramatic oil spill at the BP production well in the Gulf does not appear to have had a noticeable effect on market prices, although the possible consequences, especially for deep-water drilling operations in the future, could clearly become a very significant factor.
The recovery in prices has been very impressive; but it may not be sustainable. OPEC itself has recently issued a very cautious monthly report which argues that “recent developments have moved oil prices out of equilibrium”, and which emphasises that increasing supplies from non-OPEC countries are keeping downward pressure on prices.
It concludes, that “although demand has seen some improvement recently, it has been more than overwhelmed by the higher growth in supply”. It seems likely therefore that the present rally will lose momentum unless there is a serious deterioration in the political situation in the Middle East. Precious metal prices have also moved higher over the past month; investors are clearly still seeking “safe havens in the storm” despite the improvement in sentiment about prospects that has pushed some other commodity prices higher.
Gold prices have reached $1250 per ounce, and silver prices have also moved significantly higher, with exchange-traded funds aggressive buyers of both metals.
The World Gold Council, in its recent quarterly report, indicated that demand for gold was “exceptionally strong”, and that it was expected to remain so for the rest of year, “driven by jewellery demand in India and China, and investment demand in the US and in Europe”.
However it is clear that investment demand is the more important factor, with EFT gold holdings now above 2000 tons, and central banks also adding to their holdings again.
There is an obvious risk that the latest surge in prices will lead to some profit taking. But given the present situation, and particularly the risk of sovereign debt defaults, it would be unwise to assume that the improvement in precious metal prices in over.
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