The Hindu Business Line : Prices continue to be volatile

In many commodities, the sharp decline in prices is forcing producers to effect production cuts. In some, prices have declined to such low levels that operating costs may not be covered.

G. Chandrashekhar

Mumbai, Nov 2 Instability of the financial market and continued uncertainty over the manner and speed with which the fog would be cleared has resulted in unabated volatility in commodity prices. The none-too-encouraging outlook for global economic growth based on evidence, including leading indicators, has also resulted in price slump especially of energy and metals.

Supply response to falling prices cannot be wished away. In many commodities, the sharp decline in prices is forcing producers to respond by effecting production cuts. In some cases, prices have declined to such low levels that operating costs may not be covered or returns on investment may have turned suspect.

Demand slump

At this point of time, concerns over demand slump seem to prevail. In some cases, the price decline may have been overdone, even as upside risks to prices in the form of supply uncertainties have not disappeared. Surely, it may be a little too early to assert that commodity prices have reached their bottom; but what is clear is that it may be rather risky to continue to run aggressively short positions any more.

Improving liquidity through interest rate cuts, the US bailout package ($700 billion) and an imminent softening of the dollar may not only help arrest any further precipitous price fall, but may actually begin to lift commodity prices. Experts agree that in the medium term, the dollar will have to begin to weaken. In the event, commodity prices will receive a boost. In what timeframe it would begin to happen is hard to tell though.

Gold

Prices have continued to gyrate with the movements of the dollar. The lift that gold received last week was more the result of some weakness the greenback displayed. In the near term, the dollar is expected to continue to gain strength which would be negative for the yellow metal.

In addition, physical demand, especially in price-conscious markets such as India, has suffered even in the ongoing festival season because of sharp price volatility in recent weeks.

While investment demand continues to be strong, jewellery demand suffered in the first half of the year. This is likely to push the metal into a small surplus in 2008.

In the London spot market on Friday, gold PM Fix was $730.75 an ounce, down from $755.25/oz, the previous day. Silver too followed suit on Friday with $9.28 (AM Fix), down from $10.02/oz the previous day.

In the medium term, the dollar is likely to gradually lose strength which will help lift gold to new highs. Investor interest is the key. Other asset markets have faced more volatility than gold. Given the violent two-way movements witnessed in recent days, it may be advisable to limit the exposure to gold, at least in the short run until financial market conditions stabilise.

Base metals

With economic outlook continuing to present a gloomy picture, the outlook for metals demand too is far from encouraging. Rising stocks reflect worsening market fundamentals as does demand slowdown.

The complex continues to be hounded by bad news, but performance last week was mixed.

Zinc, heavily dependent on the construction sector currently in slump, ended the week 3.5 per cent lower. However, both lead (used in batteries) and nickel rallied by about 20 per cent.

Weaker consumption will push metals into surplus for the rest of 2008.

According to experts, base metals have been targeted for short-selling recently, leading to violent short-covering rallies but higher prices of recent days are unlikely to be sustained for long.

Aluminium, zinc, lead and nickel are currently trading below marginal costs.

Production cuts are a natural response.

In the short run, demand compression may prove too powerful to counter supply cuts.

Aluminium may be expected to trade between $1900 and $2100 a tonne. Above $2,200/t may be time to sell. As for copper, LME cash and LME 3-month are both in close proximity of $4000/t. It may be a buying opportunity below $3,500 and selling opportunity above $4500/t.

Crude

There is the possibility that the market could come under further weakness following the ongoing financial market crisis and demand constriction.

OECD demand is decidedly weak. Announced supply cuts have not boosted prices. Non-OPEC supplies are weakening. Prices are in the low to mid-60s.

Seasonal factors may come into play. But further production cuts are not ruled out.

So, one can expect a tug-of-war between weak demand and supply curtailment.

In the medium-term, however, dollar weakness will help lift prices. By the second quarter of 2009, the market could bounce back with prices moving up by 20-40 per cent from the current levels.

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