The Hindu Business Line : Slowdown fears begin to impact commodity prices

Fears of global economic slowdown are beginning to take a toll on commodity prices. Apprehensions of slowing world growth have combined with appreciation of the dollar (against the euro) to drag commodity prices lower. As is well known, a rising dollar pushes dollar-denominated commodity prices down.

The recent economic data from the world’s largest economy the US (ISM manufacturing index and auto sales) are far from encouraging. The leading indicators for Eurozone and Japan point to a sharp downturn. China too has disappointed many who anticipated a post-Olympics bounce in Chinese economic activity; but growth has been tepid, if any.

The oil market has fallen back in response to firmer dollar and genuine concerns over demand destruction in the wake of continued high energy prices and inflation. NYMEX light sweet crude (November contract) went under $95 a barrel.

Financial turmoil

Gold also may have fallen out of favour with investors, at least for the time being. Despite the financial market turmoil, the yellow metal did not perform as attractively as many would have anticipated. With things a lot more clear on the financial market and rescue package, and the greenback gaining strength, investors will have a tough call to make.

On Thursday, prices slipped sharply following selling provoked by firmer dollar and lower oil prices out-weighing safe haven related demand. There has been no change in the underlying demand and supply fundamentals. So, going forward, investor interest holds the key to gold prices.

The market is still digesting the implications of the bailout package and its impact on the dollar. The currency may gain further strength if the eurozone continues to perform poorly. This should depress gold prices. On the other hand, gold may be favoured by those who believe there is more pain left in banking and financial markets as risks may not have completely evaporated.

So, gold prices have the potential to swing both ways wildly over the next few days and even weeks. Speculators are holding large net-long positions and this creates downside risk. Caution is necessary in taking large exposure to this market. In India, a weaker rupee makes imports expensive and leads to demand compression.

Crude

The market is increasingly focussed on demand, although supply concerns continue to weigh heavily. Non-OPEC supplies are weak. Oil demand appears to be declining and the overall global demand growth in 2008 may be on par with other weak years in the past. In other words, the market is going to be torn between demand weakness and supply concerns. Demand weakness may not allow the market to stay considerably above $100 a barrel for too long and may pull prices towards the $90 a barrel mark; but supply concerns may prevent the market going down for long. It may be reasonable to expect that the crude market may be range bound, trading between $90 and $110 a barrel in the near future.

Even at these rates, imports are going to be expensive for India because of a weak rupee. Energy related inflation is unlikely to moderate anytime soon.

General

Market perceptions of the international economic outlook are particularly fluid at this point of time. Sharp movements in commodity and equity markets can be expected to continue. Overall, the markets could trade in a range broader than hitherto. If the world economy does experience a severe downturn, the market has the potential to collapse.