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05/23/2011

Raw material prices: Herd instinct taking the plunge

When Comex, the commodities exchange, recently increased security deposits for speculative traders, many investors had to liquidate their leveraged positions. The consequence: The biggest exchange rate plunge in years. This won't change anything in the long-term upward trend for copper, aluminum, nickel, lead and the like: Ever more speculative capital is flowing into the market via such investment products as ETFs and ETCs.

The events of May 6 not only caught speculative traders unawares. Without any distinctive triggering factor and totally by surprise, the steep upward trend in commodity prices in recent months ended abruptly on that sunny Thursday morning. Starting with the oil price losing 8.5 percent for the day, prices for industrial metals later also collapsed. But there was no reason for rejoicing because of the hefty markdown – not even on the management floors of domestic commodities processing companies. "According to our experience, many small and medium-sized enterprises don't have any purchasing strategy and frantically stock up at top rates in case of significant increases in commodities prices", says Gundula Jäger, Managing Director of Kerkhoff Consulting GmbH in Vienna.

ETFs and ETCs are pushing up prices.

The experts are currently divided over the question as to whether the most recent massacre of rates on the commodities markets was a lasting trend reversal or just a temporary correction. One thing for sure: The most recent price plunge on the commodities markets is not the result of a slump in the physical demand for industrial metals. With regard to copper for instance, the International Copper Study Group in its latest forecast expects – after last year's offer deficit of 253 thousand tons – shortages of 378 and 279 thousand tons for 2011 and 2012, respectively. Much rather, a trend worth billions of dollars for the investment in commodities products should be behind the exchange rate capers. Numerous newly launched products, so-called exchange traded funds (ETFs) and exchange traded commodities (ETCs), are currently inflating the market. "The volume of listed commodity products almost doubled since the end of 2009", says Philip Knüppel, Commodity Product Manager of Deutsche Bank. Volumes are huge: In mid-April, € 41 billions worth of commodity products had been speculatively traded worldwide.

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No bubble?
But most experts currently don't want to talk about a general commodities bubble. "Commodities are a volatile investment class and react very sensibly to economic developments. Accordingly, setbacks may also be severe", says Monika Rosen, Chief Analyst of Private Banking Bank Austria. For the flak on the markets for basic products, analysts are currently tracing back fundamental backgrounds primarily to the gradual slowdown of the global economic development and rising interest rates. Cristian Stanciu from Merit Group does not expect any short-term settling down of the markets: "After the significant increases in commodities prices in recent months, a correction really is overdue. Since prices are coming from far below, exchange rates may drop even more sharply than many currently expect", says Stanciu.

In the basic scenario of a continuously solid economic development, analysts currently see for the price of copper the greatest price hike among industrial metals until the end of the year 2011 (see box Forecasts). The consensus-oriented forecast by the experts interviewed by the trade journal Industriemagazin is just over $ 10,000 which is equivalent to a rate increase by about 16 percent versus the current level. Although UniCredit assumes an offer deficit for copper of at least 500,000 tons in 2012 – which is significantly above the official estimates – price expectations have been significantly trimmed back. "Our rate objectives for copper prove to be too ambitious in view of the most recent developments. We therefore reduce our estimate for 2011 from US-$ 9,750 to US-$ 9,100 and for 2012 from US-$ 11,500 to US-$ 9,300 per ton", says Jochen Hitzfeld, Commodities Analyst at UniCredit.

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Entirely without any strategy.
Most of the large domestic industrial companies are acting on the market diametrically opposed to speculative commodities traders. "Already in the bidding stage, we try to entirely safeguard against any currency and commodities fluctuations", says Michael Buchbauer, Head of Treasury of the Andritz Group. According to experiences by the consultancy Kerkhoff, the majority of small and medium-sized companies proceeds clearly less strategically in purchasing management. "Commodities are often ordered when stocks are low and not when it would be strategically advantageous", says Gundula Jäger, Managing Director of Kerkhoff Consulting GmbH. Jäger primarily criticizes that there is frequently no clear basis for decisions concerning commodities purchases. She says that company managers would hardly grapple with the developments on capital markets and have them enter into their calculations.

Using the baits of protection against inflation and national bankruptcy, the issue of new bank investment products for commodities continues to go full steam ahead. For the time being, the most recent – and according to experts temporary – exchange rates plunge on the commodities market should not yet drive investors from this newly discovered class of investments over the long run. It remains to be seen whether the economy will be heading, via the development of commodity prices, into the next financial market crisis – as recently announced by Erste Bank board member Andreas Treichl. The bankers themselves are able to control it by carefully handling the sale of their commodities products.