GO
Loading...

Outlook '08: Commodities Will Run Hot And Cold

The boom in commodities prices has captured the spotlight in recent years, but investors need to be selective going forward as some of these markets have likely peaked, analysts say.

In particular, energy and base metals should be approached with caution given expectations for a sluggish US economy, a major consumer of virtually all commodities, but grains for one may have room to rally.

“The recent decline in copper and aluminum prices tells us that the economic slowdown is anticipated,” says Dennis Gartman, editor and publisher of the Gartman Letter, a newsletter for institutional investors,

Several commodities chalked up double-digit percentage gains in 2007, boosted by positive supply-and-demand fundamentals, speculative buying and a broadening base of investors looking for portfolio diversification. Many buyers, however, have since sold, mindful of the forecast for slow economic growth or even a recession in the US.

Commodity bull markets have typically run 10 or 20 years. If the current cycle is one of the shorter ones, it is closer to its end than the beginning, some analysts say.

That may partly depend on the China factor. In a recent report, Merrill Lynch noted that essentially there are too many dollars chasing too few commodities. There are insufficient raw materials to fuel Chinese economic growth in the order of 12 percent as well as burgeoning demand in other emerging markets.

“China has the Olympic Games in 2008 and that, along with domestic activity, should be enough to keep demand healthy,” notes David Kirsch, manager of market intelligence at PFC Energy. The question is, to what extent does demand from China and the other Bric economies [Brazil, Russia and India] offset the slowdown in the US.

Boom or slowdown, investors looking to dabble in commodities no longer need to focus on picking individual stocks or trading futures. Exchange Traded Funds, or ETFs, which trade like stocks, areprobably the easiest and simplest way for investors to access commodities.

A host of new ETFs were launched in the latter part of 2007 to capture some of the money flowing into commodities. There is a marked trend for single-commodity ETFs --rather than broad-based ones -- running the gamut from agricultural commodities to base metals and energy.

Here’s a look into the crystal ball for some key commodities in 2008.

CrudeOil

PFC Energy, a consulting firm, is forecasting an average crude oil price of $78.25 a barrel for 2008, with $80 a barrel in the first quarter. PFC’s forecast is fairly typical, although some market watchers say oil could trade as low as $60.

“We see some significant upside risks if the weather turns very cold this winter,” says Kirsch. “Longer-term, the focus is the economic outlook for the U.S. and spillover to the rest of the OECD.”

Looking beyond 2008 and into 2009, PFC expects prices to fall because of the slow U.S. economy and higher OPEC capacity, especially in Nigeria. An additional downdraft in 2009 will be the end of the Bush Administration, which will remove some of the market’s risk premium, thought to be about $10 a barrel.

In addition, the metal, an excellent conductor, is seeing increase use in electronics and batteries, partly due to economic growth in China, Taiwan, India and other emerging economies. Silver is also being used more in the health industry because of its bacteria-fighting qualities.

Although conventional photographic production is down due to digital cameras, that decline seems to have bottomed out. More people are expected to print photographs using home computers and are likely to opt for silver-backed paper products for their longevity.

On the negative side, the silver market, like the gold one, will have to contend with increased supply in the next few years, especially from Central and South America.

Base Metals

Demand is largely a function of economic growth, hence the expectations for weaker prices in 2008.

Copper, which enjoyed a huge rally in 2007, has been hurt by the housing recession in the US, while supply has risen. The International Copper Study Group said consumption in the first eight months of 2007 was powered by China. In the U.S. copper usage actually fell 2.4 percent, while consumption in Europe was down 2.3 percent.

Grains

The run of the bulls is expected to continue for soybeans, wheat and corn. The lion’s share of corn goes into animal feed and greater demand for feedstuffs from the emerging economies will support prices.

Even if China’s economy moderates, per capita income will likely to continue to rise; that typically leads to improvements in the quality of food consumed, especially, higher meat consumption.

Corn is also set to benefit further from increased demand for biofuel production. The March futures contract, which traded close to $4.20 a bushel in mid-December, is expected to rally to $5.00.