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BW Businessworld

A Downward Correction

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As a monster roller-coaster ride, the commodities market is hard to beat. Three events in the past 10 days triggered a sell-off in global commodities markets and put them in a tailspin unlike any that we have seen before. Commodity prices fell between 2 and 17 per cent across categories (see ‘All Fall Down').

First, QE2 — the second round of quantitative easing by the US Federal Reserve — comes to an end in June; second, the Chicago Mercantile Exchange and the New York Mercantile Exchange increased traders' margins to curb "excessive speculation: silver prices dropped 30 per cent, oil prices also declined relatively rapidly; basic metals and agricultural products — cotton and coffee among them — followed suit.








 

Market reports suggest that investing legend George Soros, billionaire hedge fund manager John Burbank and JP Morgan offloaded positions in precious metals, particularly silver, where the costs of trading went up by 84 per cent (in margins). Oil prices fell after the US Department of Energy released data on its strategic petroleum reserve and inventories that were much higher than expected (up by 3.8 million barrels to 370.3 million barrels, as on 6 May).

"Things that rise quickly without sound fundamentals also come down too fast and that's the reason why commodity prices plunged, especially silver," says Naveen Mathur, associate director, commodities and currencies, at Angel Broking, a Mumbai-based securities firm. "It triggered margin calls and stop-losses that intensified the fall."

Does this mean that Indian manufacturers can look forward to lower input costs? Not exactly. While price of copper, lead, zinc and natural gas for the year are down by 8 per cent, 9 per cent, 11 per cent and 4 per cent, respectively, prices of iron ore, aluminium and crude oil for the year are still trading higher by 2 per cent, 2 per cent and 13 per cent, respectively. Prices of coffee (22 per cent), corn (10.5 per cent) and cotton (5 per cent) are still up.

A further correction is not considered very likely, at least in the immediate future. "Prices will remain range bound, with downward bias," says Vivek Gupta, managing director, GEPL Capital, a financial services firm. Governments across the region are trying to control high inflation; holding inventory could become expensive and players may offload positions, softening commodity prices, he adds.

For Indian consumers, the biggest concern will be the impact of oil prices. They may have fallen, but not enough, and definitely not as low as the average for the Indian crude basket of roughly $85 for 2010-11. With Brent crude at about $115 a barrel, likely to stay that high, government finances will feel the strain.

This much seems very likely: the government will have to raise the administered prices of diesel and liquefied natural gas, despite the potential hardship for the public at large, and the impact on consumption demand. The Reserve Bank of India had hinted as much in its annual monetary policy on 3 May this year.

Despite actions by central banks around the world, global liquidity — and thus speculative commodity investment — will continue its run for a while longer. The commodity price cycle may correct, but slowly. So don't hold your breath waiting for a big fall.

(This story was published in Businessworld Issue Dated 23-05-2011)