Market Insider

'Cliff' Keeps Commodities Hanging in the Balance

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Commodities drew in a hefty amount of new investment dollars in 2012, but their less-than-stellar performance raises questions about 2013.

The money invested in commodity funds was up 86 percent to $20.8 billion dollars in 2012, according to EPFR Global. But in terms of broad performance, the S&P Goldman Sachs Commodity Index is down 1 percent so far this year, on track for its first annual loss since 2008.

Year-end tax selling and caution about the "fiscal cliff" were pressuring all sorts of commodities prices Friday.

The commodities markets close out 2012 trading on the same theme as all markets – uncertainty. Analysts say the concerns about the fiscal cliff, which is the dual expiration of tax breaks and the onset of spending cuts if Congress fails to act, are making the final days of the year difficult.

Because the "cliff" could send the economy into recession if there is no action, the outlook for the first part of 2013 is especially unclear.

Oil had a strong negative reaction Friday to the lack of agreement and failure of the House to vote Thursday night on Speaker John Boehner's "Plan B" version of legislation that would raise taxes only on families earning more than $1 million. West Texas Intermediate crude fell $1.75 to $88.38 Friday, in a selloff that hit all risk markets.

"It seems like most participants are sitting on the sidelines until we get a deal. Our 2013 outlook is higher as the economy continues to expand. West Texas Intermediate will most likely be around $100, with the first half likely in the $90s and second half over $100," said Jonathan Nejad of Parity Energy.

Nejad says that the key factors contributing to moves in oil next year are likely to be the debt ceiling talks in Washington and tensions in the Middle East. While calm for the moment, Middle East tensions have not disappeared and should keep a premium built into the oil price.

Meanwhile, despite being pummeled lately, gold has been a solid performer this year. Nearly 84 percent of funds that are invested in physical commodities are invested in gold and year to date. The metal has climbed nearly 7 percent. Gold is on track for 12 consecutive years of gains and a return of over 500 percent during that period.

Most analysts predict that gold will go higher in 2013, but the recent decline may not be over.

"Right now metals are experiencing the year-end effect. When commodities are traded like stocks the year-end activity gets very volatile. We saw the same thing last year when PMs liquidated GLD and other metals ETFs," said Jack Bouroudjian, CEO of Bull & Bear Partners.

Still, those who are more skeptical think that a reduction in fear is driving the metal price lower, because there is less need for a safe haven and inflation hedge. If a "cliff" deal is reached, it's expected that there would be more rotation out of gold and into riskier assets.

"While the fiscal cliff creates uncertainty, going over it significantly reduces the deficit, and would strengthen the dollar. A deal benefits the economy, which would move markets higher. Gold could continue to move lower over the next year as the economy expands and the deficit is taken more seriously," said Nejad.

A beneficiary of that rotation could be agricultural commodities, a source of strength in 2012. Soymeal is up nearly 40 percent on the year, while wheat is up 23 percent.

Other softs include lumber, up 37.4 percent year-to-date, wheat (up 23.4 percent), platinum (up 13.8 percent) and gold (up 6.6 percent).

Soymeal and wheat prices have been up as grains' balance sheets have grown tighter in the wake of this summer's drought in the United States, coupled with growing demand. Lumber prices have been on the rise due to housing needs for both for new homes but also to re-build homes damaged by Super Storm Sandy.

"Weather was the number one factor with respect to soybean meal and wheat – specifically the US drought. For lumber, Super storm Sandy drove prices higher. But you can't say that those trends will continue though because you can't predict the weather; these are situations that came up this year but won't necessarily be issues next year," said George Gero Senior Vice President at RBC Wealth Management.

Some softs performed poorly in 2012. Coffee fell 36.2 percent; sugar fell 17.4 percent; and orange juice fell 16 percent.

"Cotton and sugar are well supplied and close to cost of production for most major producers, so I don't expect them to go much lower," said John Angus Reeve of Standard Chartered. "Consumers should take advantage of this," he added.

Bouroudjian says that "sugar went through a huge production glut coming out of Brazil which has been worked off and cotton is one that could turn back up."

And then there are the commodities that have flown under the radar; the trades that have been less crowded but could draw more attention next year.

"Natural Gas got some attention as a potential fuel, but from a trading perspective, it seemed to be quiet — indicated by its range for the year. It opened the year around $2.90, hit a low of about $1.90, then a high of over $3.90 — now sitting at about $3.50. Given that range, I would have expected to see more participants come into the market," said Nejad.

And while it may not be one of the most talked about commodities, John Angus Reeve of Standard Chartered is watching long-term natural rubber. "Consistent growth in global consumption, but too little investment in plantations; it takes seven years before you can tap a rubber tree, so tropical acreage is going under palm oil, sugar, and other row crops where cash returns and harvest comes faster. There may be a big bull market in natural rubber eventually," Angus Reeve said.

—By CNBC's Jackie DeAngelis; Follow her on Twitter: @JackieDeAngelis