Gold likely to become vulnerable at higher price levels.

G. Chandrashekhar

Mumbai, Jan 4

In 2008, commodity markets witnessed extraordinary volatility between the two extremes of the price spectrum. First, a huge bull run took prices of a wide range of commodities - energy products, precious metals, base metals, industrial metals, polymers and agriculture - to stratospheric heights, only to be followed by an equally unprecedented slump in prices when a combination of events hit the world.

Economic slowdown worsening into a recession, drying up of liquidity across markets, build up of inventory signalling demand slump and exit of speculative capital — all contributed to a huge collapse of commodity prices. A crisis of confidence currently pervades the marketplace. The poor price sentiment continues.

Stimulus packages

Fearing serious socio-political backlash, across the world, many governments have begun to bail out industries. Through massive dose of injection of investments (stimulus packages) in infrastructure and other projects, governments seek to improve liquidity, reduce interest rates and attempt to generate employment and incomes as well as help drawdown burgeoning inventories of commodities.

Currently, demand slowdown is on top of market concerns. Demand compression and rising inventory are forcing producers to cut output and defer or even abandon fresh investment in production capacities. So, what can one look forward to in 2009? How long and how deep the recessionary conditions would go is currently a matter of debate. There would be a time lag between injection of investments and results to manifest. It could be anything between two and three quarters. Meanwhile, what is nearly certain is that the dollar would gradually weaken vis-À-vis major currencies, especially the euro. This will lift commodity prices designated in dollars. Weaker dollar and falling interest rates will combine to push inflation higher in the US. Geopolitical uncertainties are sure to linger.

Gold

Weakening dollar and potential for inflation to rear its head may prove positive for gold. The yellow metal is currently trading at around $850 an ounce; but it failed to decisively break through the key resistance level of $880. Gold becomes increasingly vulnerable at higher price levels because it is sure to lead to compression of physical demand in major markets such as India. Investment demand is the key. However, investors may not flock to gold in large numbers once other markets (mainly equities) return to some semblance of orderliness.

All these factors are sure to make gold prices highly volatile. There is a wide range within which one can expect the metal to trade in 2009; and the range is between $650 and $950 an ounce. It may briefly breach the upper limit and may even break into $1,000 levels, but would find it rather tough to stay at those elevated levels.

Base metals

The complex is currently in the doldrums. Western world consumption of base metals - construction, automobiles - has shrunk. Asian consumption will support and provide a floor for prices. It may take several months for the various stimulus packages to begin to show results. Once they start doing, some kind of supply bottleneck can potentially develop because of output cuts undertaken by a number of producers. This can lead to price spurts. Weakening dollar will be supportive. On current reckoning, much of the price action is expected to be in the second half of the year.

Meanwhile one can expect several short-covering rallies over the coming months; but given weak demand, such rallies will be short-lived.

Crude

It may be reasonable to assume that the crude market has bottomed out. Assuming all OPEC members abide by their earlier output cut decision, any further slashing of output may lead to over-tightening.

A weakening dollar will be supportive. Non-OPEC supplies are most unlikely to expand. Demand side still looks weak. But given the criticality of crude to world economic growth, when the process of economic recovery starts, crude can potentially see a significant spike from the current levels.

Prices have the potential to trade between $55 and $75 a barrel in 2009.

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(This article was published in the Business Line print edition dated January 5, 2009)
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