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All Over For Commodities?

The sense of doom overhanging the commodity markets at the moment is palpable. Crude oil, platinum, copper, and agricultural commodities, to name a few, have fallen sharply over the past five weeks, heralding cries from commentators that we are at the end of the commodity bull market and that the commodity bubble has burst. This is a large exaggeration, we believe: a better way to think of this is as a mixture of cyclical / seasonal weakness in the midst of a supercycle together with intervention in commodity markets.

Although the weakness in commodities is being blamed on growth concerns, we believe that two factors are responsible for much of the recent weakness. Firstly, the decision by Saudi Arabia to oversupply the crude oil market has succeeded in bringing the oil price down. Investors are anticipating a build in crude inventories that should start from later this month. And as we noted yesterday, concerns about political interference in commodity investment and speculation are triggering heavy outflows from commodity index players. Add in less liquid August markets, seasonally weak demand for industrial metals and some nasty growth / demand newsflow and the rest is history and markets have corrected sharply.

So where do we go from here? In the near term, it seems likely that crude oil is set to head lower and index money will probably continue to flee commodity markets. Accordingly, it will be hard for the commodity complex to prosper in the short term. But some commodities are looking decidedly cheap (platinum, for one) and the recent downward momentum will have encouraged technical-trading funds to be short. This should make investors wary of simply getting short all commodities at any price and rather look at the positions that are crowded.

We suggest that there are a few crowded long positions in the metals space that may trigger weakness in days and weeks to come. Investors and speculators remain pretty long gold via futures and ETFs despite the $80/oz + retreat from recent highs. We worry that a close below the 200-day moving average (about $891 cash) may trigger CTA selling, although our technical analysts say this number is not very important. If gold closes weakly today we will throw the towel in on our strong 1m and 3m views tomorrow.

The other crowded metals trade is long-dated aluminium, with investors having bought into the argument that long-term energy scarcity and higher prices will drive the aluminium price higher in the long term. We agree with this view but note that with commodity prices - including energy - correcting at the moment, this position may be vulnerable to profit-taking.

We would be cautious about getting short copper here. We noted yesterday that Comex shorts increased further last week and we would guess that this position have grown further since: the arbitrage between Shanghai and LME copper is narrowing, indicating that the Chinese hate copper less than the rest of the world - and since China has the potential to buy a LOT of copper at the right price, we recommend watching this arbitrage closely. LME stocks have increased again today - and will probably increase further through the northern hemisphere summer as we argued last week, but visible stocks remain very low and, at the right price, copper will find keen buyers - and not just in China.