The Hindu Business Line : Commodity market likely to remain volatile

Factors that count
Oil market continues to be driven by supply side and demand side factors.
Fundamentals will justify a move higher in base metals prices before the end of 2006.
Precious metals will take a cue from the US economic growth and inflation pressures.
High oil prices lend considerable strength to bioenergy sector

Mumbai , July 25

Growth versus inflation dilemma; geopolitical concerns; tightening demand-supply fundamentals; role of funds — all these factors seem to be working simultaneously in the global commodity markets at present.

No wonder, volatile trading conditions have become persistent in the commodity markets around the world; yet activity in this sector is hardly slowing.

Indeed, open interest in the US commodity markets continues to grow and non-commercial activity has climbed to its highest level for over two years.

To persist

Experts assert volatile conditions will persist for some time yet; but view fundamental risks, especially in energy and industrial metals markets, as pointing to a resumption of upward trends before too long.

The exposure of tactical investors to the long side of US commodity markets has expanded rapidly over the past few weeks and across several other major markets.

The net length has risen to its highest level since early 2004. The biggest increases by commodity sector over recent weeks have come in energy and agriculture.

Net long exposure to the energy sector has been boosted by a rare move into net long territory for US natural gas speculators who have tended to play this market consistently from the short side until recently, Barclays Capital pointed out in a report, adding that in oil markets there has been significant increase in net long exposure to refined products.

Diverse in agriculture

However, within agriculture the trends have been diverse. Soyabean, cocoa, wheat and corn markets are attracting the bulk of new buying.

The message is that the trend to reducing risky exposure, evident in many financial markets at present, is less prevalent in commodities, an analyst commented.

Oil market continues to be driven by both supply side and demand side factors with the constantly changing geopolitical situation becoming the focal point because of its supply disruption potential. No doubt, oil prices have fallen back from their recent highs; but fundamentals continue to support prices in the mid-to-low $70s. In the short-term, the down side seems limited.

On the other hand, if the West Asia situation were to worsen, the upside risk would increase. The US gasoline market is currently the focal point for the problems posed by strong growth in demand for light products globally, plus the lack of upgrading refining capacity to meet the demand.

Experts assert further upside from current high levels is still possible.

Speculative activity has moved up in heating oil recently and a move higher in this market should not be ruled out, given the low level of production at US refineries that are currently favouring gasoline.

Base metals

Although tight fundamentals continue to be a key feature of the market, concerns surrounding inflation and monetary policy have resulted in steep corrections and volatile price moves of recent weeks.

If the Fed were to raise interest rates further, as anticipated by some analysts, the recent pattern of sideways and highly volatile trading is likely to continue for most of the current quarter. However, fundamentals would justify a move higher in base metals prices before the end of 2006, and the strength may persist into early next year, according to analysts.

Precious metals

The market is interestingly poised. Clearly, the market will take a cue from the US economic growth and inflation pressures. If these are stronger than implied by the recent more-dovish-than-expected comments of the Fed chief, there is scope for some limited upside for the US dollar in the coming weeks.

As we move towards the end of the Fed's tightening cycle and markets start to anticipate a slowdown in the US economy in the first half of 2007, the EUR/USD is likely to weaken significantly. Gold is expected to remain volatile in largely sideways pattern over Q3. There is potential for the yellow metal to resume a clear upward path in Q4.

Bio-energy

High oil prices lend considerable strength to the bioenergy sector. Bioethanol production from both corn (maize) and cane is rising to meet strong US demand. CBoT corn prices are therefore seen having an upside bias. NYBoT cotton prices look positive due to rising global cotton demand, unmatched by production increases. Strong projected Chinese cotton demand will drive global prices.