Why the Commodities Selloff May Be Nearing an End

The commodity markets have spent the past five months or so pricing in a fairly dire global economy, making the class as a whole ripe for a rebound.


While the prognosis in the US and abroad remains weak due to an intensifying debt crisisand an inability to generate substantial job growth, areas such as energy and grains in particular often prove resilient in such circumstances.

So even with storm clouds ahead, commodities may have done their work in terms of accounting for the damage and have room to rise, according to experts across the diverse range of assets that make up the class.

"At this point, the concerns over European sovereign debt and the European financial sector are considerable. However, our economists do not yet expect the financial stress in Europe to trigger a world economic recession, as was experienced in 2008," economists at Goldman Sachs said in a recent analysis.

"Consequently, we view the turmoil in Europe as a headwind to world economic growth, which we expect will only take away some of the upside to commodity prices, not reverse it," the firm added.

The distinction is important, as is the realization that conditions in developed markets such as the US and Europe are only part of the equation when determining the behavior of commodity markets.

Specifically, emerging markets such as Brazil and India continue to demand various goods such as energy and foodstuffs that will keep a floor under those areas.

Also, with the Federal Reserve continuing to keep monetary policy loose and the dollar weak, that also will provide a boost to commodities.

"The lesson of the events of 2007-08 is that the emerging market economies, and by extension the world economy, increasingly can be relatively resilient to a slowdown in the developed market economies like the United States and Europe, as long they are facing simply the transmission of real economic weakness, and not financial stress either to trade channels or their own banking systems," the Goldman team wrote. "In short, if we can avoid a global financial crisis, we can avoid a global recession."

Goldman in fact is maintaining its long positions across a spectrum of commodities — brent crude , copper, zinc, soybeans and gold among them — in anticipation that even with an expected economic slowdown, the market has not been caught off guard to the extent that it was when the financial crisis began.

The Jefferies CRB Commodity Indexhas sold off more than 15 percent since its late-April high, and the damage has been particularly severe in gold and oil , as well as economic bellwether copper, which had held up fairly well until early September when the European debt crisis took another downturn.

Parsing out which areas will hold up best against what is likely to be continued twists and turns in the euro-zone soap operawill be critical to investors, says Shelley Goldberg, director of global resources and commodities strategy at Roubini Global Economics in New York, the firm run by famed doomsayer Nouriel Roubini. RGE is predicting a 60 percent chance of global recession.

"You kind of have to trifurcate the sector into three chunks," Goldberg says. "Each and every commodity doesn't react in a linear way."

Industrial metals like copper and silver "tend to get hit the most" during economic slowdowns, while energy holds up better because of its influence from external factors such as the Organization for Petroleum Exporting Countries and its control over prices, Goldberg says.

Grains will do the best due to continued demand from emerging markets and "price inelasticity," or the sector's ability to demand higher costs because of its necessity in daily life.

"Despite a global slowdown, you have a much higher consumption of protein through the emerging market world," she says. "Even with a slowdown in emerging markets, just because of the growth of the middle class, which continues to eat more protein, that requires corn-fed animals to produce things like eggs and poultry and beef."

The metals market is a bit trickier.

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Growth in copper will be hard to maintain until the global economic picture — particularly in China — gets clearer.

However, gold is another story. The yellow metal has tumbled since a brief pop over $1,900 an ounce in September, and has not fared well even as a safe havenagainst the European troubles.

Julian Jessop at Capital Economics, though bearish on commodities as a whole because of the looming slowdown, believes gold has a better future.

"Gold is the main exception to our generally bearish view on commodities and should reach new highs if, or when, the crisis in the euro-zone escalates again," Jessop said in a research note. "Recently, the general return of confidence in the dollar has reduced demand for gold as a hedge against a collapse in the US currency. But we do not expect this to hold back gold much longer."

Indeed, Europe remains the wild card for commodities that, at the very least, seem to have found a bottom even if they don't show any immediate big gains, says Todd Horwitz, senior strategist at the Adam Mesh Trading Group in New York.

"There's no lack of supply, there's normal demand and the commodities are trading at pretty much a fair price," Horwitz says. "I don't see anything to really shake this out unless we get some major news out of Europe."