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Everybody's Into Commodities - - You'd Better Duck

April 19 (Bloomberg) -- Buy me a sugar futures contract. Get some shares of any company that mines copper. Maybe put money into a commodities index fund -- anything that smells like metals, oil or foodstuffs will keep on soaring.

Commodity prices have been doing just that lately. The Goldman Sachs Commodity Index, which tracks prices for 24 energy, metals and farm products, yesterday rose 1.8 percent to a record. Everyone from hedge funds to Uncle Phil's dentist are chasing after more easy money.

Wall Street, of course, eagerly obliges the fun-seekers, brokering trades, talking up the rallies and creating new speculative vehicles.

Look at the popularity of the PIMCO Commodity RealReturn Strategy Fund that invests in commodity derivatives (don't ask). Its assets are now $12 billion. On April 10, people began trading shares in U.S. Oil Fund, which tries to mimic movements of contracts for future deliveries of West Texas intermediate light crude oil.

This must mean that the markets are peaking. For certain, the flood of speculative money has unhinged them from reality.

While global economic growth has increased demand for commodities -- eroding inventories of copper and sugar -- speculators have pushed prices well beyond what would be set through normal negotiations between producers and customers.

Track Record

It's easy to see what's sucking folks in. The Goldman Sachs Commodity Index is up 13 percent so far in 2006. By comparison, the benchmark Standard & Poor's 500 Index of stocks is up 4.8 percent this year. And in the same time, U.S. Treasury 10-year securities have declined, the yield rising to 4.98 percent from 4.39 percent.

Copper, which is used in wire and plumbing, traded at a record $6,500 a metric ton for future delivery in London yesterday. Copper-miner Phelps Dodge Corp., based in Phoenix, has declared about $1.3 billion in special dividends in the past six months and says it has another $700 million available for dividends or stock buybacks.

Crude oil futures also hit an all-time high yesterday in New York at $71.60 a barrel. Sugar, used in food and as a gasoline substitute in Brazil, is frothy too. Even zinc, used to coat steel to keep it from corroding, set a record last week. And as zinc goes, so goes lead, which is used in car batteries.

Whipsaw

Speculators have forgotten, if they ever knew, that commodities are notoriously volatile. It's simple. When prices soar, miners mine more, factories make more and farmers plant more. Soon supply outruns demand and prices drop, often disastrously. Check any economics textbook.

What if simultaneously extraordinary economic growth rates in China and India slow to just above-average? That would reduce demand for energy just at a time when, as analysts for Paris- based Societe Generale SA pointed out last week, Saudi Arabia and other members of the Organization of Petroleum Exporting Countries rev up crude oil production.

And what if Americans stop buying gasoline-thirsty sport utility vehicles at the same time? Glowing predictions for sugar- based ethanol might then look off-the-mark.

More sluggish economies would also crimp demand for steel and aluminum. A slowdown in U.S. homebuilding can't bode well for sales of copper wire and plumbing.

The world won't fall apart when commodity prices collapse. Pension funds that might invest 5 percent of their assets in commodities can afford the hit. Uncle Phil will suffer more.

Commodities hold key to economic power
Thu Apr 27, 2006 12:03 PM BST

By Pratima Desai

LONDON (Reuters) - Raw material resources will determine country rankings in the world economic pecking order in years to come as strong demand and limited supplies ensure commodity prices hold their upward trajectory.

Hedge funds say demand for the commodities that countries produce, plus demand for their stocks, bonds and currencies, will likely dominate market and investor psychology for at least another 10 to 15 years.

"We won't be thinking of countries in terms of emerging or emerged but whether they have commodities or not," said David Murrin, chief investment officer at hedge fund Emergent Asset Management.

Countries that will benefit from the raw materials windfall include Russia and Canada with plentiful precious and base metals alongside oil and gas.

"We are 15 years away from the peak ... The last (commodities cycle) peak was in 1975 ... Since then the system has mostly been consumer and technology driven," Murrin said.

Middle Eastern countries with large reserves of oil are also likely to figure in the economic league tables, but the hedge funds interviewed by Reuters did not mention Africa.

However, Asian economies such as Japan, with few natural resources cannot be ignored as its economy, reliant on exports until recently, is reviving and is likely to show much higher growth rates as consumer confidence and demand strengthen.

"There will be exceptions of course," a hedge fund manager said.

"But in the main, investments will be concentrated on things to do with commodities, whether they be stocks, bonds or currencies such as the Canadian or Australian dollars."

The most obvious losers are likely to be countries in Western Europe, mostly reliant on imports of commodities that are becoming increasingly expensive.

MISSING IMPORTANT NUANCES

Other countries likely to benefit from the commodities bonanza include Brazil, Peru, Mexico, Chile and South Africa, rich in precious and base metals.

"Resource-rich countries are certainly benefiting from a commodity boom right now," another hedge fund manager said.

"But does that determine their success going forward? Maybe not, because other factors are economic growth ... Saying the world is divided into commodity and non-commodity producing countries is missing some important nuances."

China has a lot of metal and oil resources. But the country doesn't have enough copper or oil to meet its needs and has to import both. So, how does it fit into the commodity scheme?

China's strength, some hedge funds say, is an abundance of cheap labour, which will help sustain high growth rates.

Other countries in Asia, such as India, are also likely to be exceptions. India's educated work force and a growing middle class with an appetite for consumer goods will continue to underpin strong economic growth.

Recently investors have flocked to Asian stocks because of growth and earnings potential and to Latin American bonds because they are backed by rising revenues from the raw materials bonanza.

"(Latin American markets) have been determined by the ability of lenders to pay off their debt ... It's to do with credit quality," the hedge fund manager said.

"In Asia, the main focus has been equities ... Equity investing is determined by the ability of companies to grow and to be profitable ... Underpinned by strong economic growth."

But many hedge funds expect this to change and are already eyeing up stock markets in Latin America, which they expect to catch up and probably overtake Asia.

"You can't bet against Asia entirely, but it will be less easy for them to make an impact against commodity-producing countries," said Dawn Kendall, investment directors at hedge fund firm GAIM Advisors.

"Asia has a very high savings ratio and in the long term that is deflationary."

The high savings rate was one of the biggest problem in Japan during the 1990s, when deflation and recession dominated consumer psychological and demand collapsed.

The United States with a low, sometimes negative, savings rate, does have raw material resources, but has to import around half of its energy needs, which hedge funds say will damage the country's growth prospects given record high prices.

Duck? I am not really into it yet. Any way, does anyone know anything about Commodities' funds (not future)? Anyone wants to share his or her experience?