The Hindu Business Line : Rally in commodity prices may continue in Q1

THERE is every indication that the commodity rally of late 2005 will continue into the first quarter of the New Year, if not beyond; and may flatten in the second half of 2006.

In a general sense, commodity and energy prices are expected to remain at elevated levels and are likely to peak in the first quarter, given the demand-supply fundamentals, global economic growth, inflation and interest rates.

Technical analysis, too, suggests there could be a strong upward thrust to prices of many commodities.

Investors are becoming more discerning about the choice of their exposure, experts said adding that there have been significant changes impacting the commodities investment climate over the past year, the most important one being large price appreciations resulting in record or multi-year highs in many commodity sectors.

A survey done in New York recently suggests that investors are planning a more diverse approach to commodity investing than in the past. While index products have so far been most popular, the passive approach may give way to a mix of passive and active management strategies. Commodity structured products are catching the attention of investors.

"In 2006, investors are likely to progress from passive physical longs to derivative strategies, underlying equities and industrial services sector," commented an expert.

Investors are seeking increasingly positive exposure to energy markets.

Crude market is likely to find strong support in the first quarter. Although the sedate nature of crude market in the last few weeks of 2005 caught many by surprise, there is unlikely to be a slowdown in demand anytime soon, nor can there be a surprise increase in supplies.

Weather continues to be the key short-term factor determining energy price direction. From the current levels, fundamental downside risk looks rather limited, while gross short position is still large and the risk for more short covering remains. The price target is $ 70 a barrel.

Supply constraints remain severe across the base metals sector due to cost pressures from high raw material prices (including high energy prices) and critically low level of inventory. Demand, on the other hand, continues to be robust. A general guidance for base metals investors would be to buy on price dips.

Among base metals, copper looks distinctly bullish and seems poised to top early in 2006. It should surprise none if prices threaten to breach $5,000 a tonne; but soon, there could a correction that may take the metal down to $4,000.

On the other hand, there may be no dramatic changes in other base metals.

There is not much of history to work with gold at above $500 an ounce. As fundamentals have receded into the background and large speculative funds call the shots, a strong upside is seen. There are possibilities for the yellow metal to rally towards $550/oz in the first quarter.

Silver, too, has a strong potential upward. The next price target, according to analysts, is $9/oz. Oilseeds and vegetable oil complex continues to remain delicately poised.

Supplies are comfortable and weather conditions in main producing countries satisfactory. There is not much of a downside from current levels, but there is no big upside either. There could be a slight improvement in vegetable oil market in first quarter with seasonal decline in palm oil output and new bio-diesel plants going on stream. Large inventory would cap the upward movement. Crude palm oil may move up to Malaysia ringgit 1,475-1,550 a tonne range in the first quarter.

Sugar has seen enormous gain in recent months. Huge funds are locked in the commodity. Large diversion of cane for ethanol in Brazil and WTO ruling against Europe's sugar export subsidy are positive factors. However, funds can decide to pull the plug anytime. So, caution is necessary.

Like in the past, energy and metals market in India would move in tandem with global trends. One should be ready to witness gold prices moving towards Rs 9,000 for 10 gm.

The sugar market here is most likely to witness a price spike in the first quarter, probably after mid-February, going by domestic demand-supply fundamentals.

The production numbers currently coming out from industry circles and Government sources and on that basis, projection for the whole season, appear to be overstated.

The wheat market has been hardening last few days. The fine cereal has a further upside. It may cross Rs 950 a quintal sometime in January and can possibly race towards the Rs 1,000 mark. As the next crop is a good four months away, tight supplies and minimum public stocks would continue to lend a firm tone to the market, notwithstanding satisfactory crop condition.