The prices of many commodities have returned to their ’05 levels

The prices of many commodities have returned to their '05 levels. Such a huge decline in commodity prices, and that too, over a short period, raises questions about their future direction. Kiran Kabtta elaborates

    EVEN AS THIS article was being written, gold fell to $713 per troy ounce and was heading towards one of its biggest weekly losses. Crude oil has already hit $65 per barrel, having fallen 56% since its peak of $147 per barrel in July this year. Prices of base metals, one of the worst performers of recent times, are down by 40-50% since the beginning of the year.
    The prices of many commodities have returned to their '05 levels. Such a huge decline in commodity prices, and that too, over a short period, raises questions about their direction in future. The commodity markets, which have witnessed a bull run since '05, have not remained unaffected due to the global financial crisis and the ensuing credit crunch.
    As the equity meltdown continues, the commodity markets have witnessed aggressive selling. The domino effect among various asset classes has taken its toll on commodities as well.
    Equities were at the forefront during the last bull run in financial assets, which began in '03-04. The boom in equities acted as a leading trigger and source of funds for investors in other asset classes.
    Ranging from energy and agriculture commodities to precious and industrial metals, the market started finding reasons to buy into them with a bullish outlook.
    Higher crude oil prices post Hurricane Katrina, drought in major wheat-growing areas of the world, the El Nino and La Nina effects, which caused floods and droughts in various parts of the world, were some of the physical factors that were pushing up commodity prices.
    The China Olympics proved to be yet another trigger for a rally in industrial commodities. The ensuing construction boom in China managed to push up the prices of most base metals.
    That was then. The weakening of equity markets following the subprime crisis changed things dramatically, impacting commodity markets as well. The first to feel its effect were base metals and agricommodities. The energy basket dominated by crude oil and the precious metals basket led by gold managed to pull over, even while other asset prices had started to cool down. Crude oil prices peaked out amidst bearishness in global equity markets. This was primarily due to shifting of investment demand from equities to liquid commodities like crude oil and gold.
    However, the crude oil market could not sustain the investment boom for long. With the world's largest economy steadily being strangulated by the credit crisis and claiming its victims in the form of erstwhile top financial institutions, fund managers had to withdraw from the oil market.
    The month of October has proved to be a major dampener for the commodity markets. The S&P Goldman Sachs Commodity Index, which showed a modest gain of 1% during the nine months ended September '08, is now in the red with a 28% loss. The index value, at a little over 5,000 points, is the same as it was at the beginning of '05.
    So, is this meltdown in commodities a blip in the long-term bull run or a conclusion of a threeyear bull run? Now that the surplus investments are out, the markets are likely to stabilise around the fair fundamental values in case of each individual commodity.
    Probably, a recovery in equity markets may yet again signal an entry into commodities on a case-to-case basis. However, investors are definitely going to be more cautious the next time. As a result, we may not see such mountain-like formations for quite some time to come.
    kiran.kabtta@timesgroup.com