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Dec 8th 2009

Three Catalysts That Will Drive Commodity Prices

Commodity prices will see most of 2010 a reasonably close repeat of 2009. Look at the chart below and figure how much more there is just to go.

By mid-November 2009 it was very clear that commodities were once again in a major bull market. A few commodities have been left out – coal, natural gas and many foodstuffs have experienced lackluster performance – but many of the others (such as the metals, in particular) have had an exceptional year.

Commodity Group (CRB Index Reuters) Price Change Nov. 2008/09
Metals +74%
Raw Industrials +38%
Continuous Commodity Index +34%
Individual Commodities Price Change 1.1.09 – 16.11.09
Gold +30%
Silver +61%
Copper +119%
Oil +65%
Three particular figures to keep commodities on their upward trajectory.

1) The U.S. Federal Reserve has kept short-term interest rates close to zero all year, and other central banks around the world have pursued similar policies. Even countries that haven’t had significant recessions – such as China – have pursued exceptionally expansionary monetary policies: China’s M2 money supply was up 29.4% in the 12 months through October, far above the country’s economic growth rate for that period.

As all that money hasn’t gone into housing – the global housing markets are still bombed out after their earlier excesses. – it hasn’t gone much into stocks too.

But, all that money had to go somewhere, all the stimulus money has gone into commodities.

2) While the rest of the world has been mired in recession, China has had a pretty good year, and so has India. In the third quarter, China’s gross domestic product (GDP) increased 9.5% over the previous year, and India is expected to post a rise of at least 6%. That has caused soaring demand for raw materials, because lifting the 2.5 billion inhabitants of those countries out of poverty generally requires lots of supplies. China leapfrogged the United States this year to become the world’s largest automobile market with sales of 11 million cars and light trucks.

This escalation in demand is likely to continue. And that will put added pressure on global raw materials supplies. In general, we have plenty of commodities, but opening up new production takes lots of time and money, so rapid demand growth pushes up materials prices.

3) Hedge funds and other speculative investors are piling into commodities. They are buying not just futures, physical commodities as well. The supply of most commodities is a small fraction of the volume of hedge funds outstanding, meaning that prices could shift quite sharply as supply disruptions occur. While a hedge fund buying commodity futures eventually has to roll its position over into the next fund, a hedge fund buying a tanker full of oil or a freighter full of copper ore is tying up part of even higher prices.

3 key factors For Maximum Profit with CommoditiesGenuine industrial demand

Speculator interestHow quickly can new supplies be brought on stream

For some commodities – chiefly gold and oil – ramping up on new supplies is a difficult and lengthy process. Gold production has declined by about 2% in the last few years, in spite of rising prices, and most gold ores are in low concentrations – hence ramping up production is very difficult, whatever the price. The same is more or less true for oil, with the added challenge that many of the best potential fields are in countries run by tinpot dictators, who get greedy when the prices rise, and try to push them up further.

Coal has some upside potential, as does natural gas (to a lesser extent). There is unlikely to be much speculative demand for them, but increasing supply is difficult and demand from China and India is increasing fast.

At the other extreme, agricultural commodities are unlikely to see much of a bubble – it’s just too easy to farm more land or use better seeds. Price run-ups in agricultural commodities tend to be short-term, caused by bad harvests.

Hence the metals are the best bets for upside, together with oil.

U.S. Federal Reserve Chairman Ben Bernanke has said he will keep interest rates around zero “for an extended period.” This fits with his record, which has been consistently to have the lowest interest rates possible while prattling incessantly about non-existent deflation. With low level interest rates – FED is likely to keep them for far longer. That has to be good for the commodities market. At some point, this will reverse and the world’s central bankers will get serious about interest rates. Then commodities prices will crash as they did last autumn. However, this is unlikely to happen before 2011.