Analysis: Commodity bulls, bears polarized by bond yield surge

By David Sheppard

NEW YORK (BestGrowthStock) – A surge in U.S. Treasury yields is forcing commodity traders to confront the less-familiar bond market, with views split over whether one of the biggest two-day gains in years is a signal to get out in front of a stronger economy or brace for the worst as interest rates rise.

Talk of price spikes and asset bubbles have done little to calm rattled nerves as gold and copper reached record highs this week and oil touched $90 a barrel for the first time since the price crash of 2008.

For now, analysts say gyrations in the bond market are no reason for commodity traders to panic — or get too excited about the strength of the economic recovery. But bulls and bears alike are being warned to keep one eye on U.S. Treasuries, despite wildly differing views on what the rising yields mean.

“We need to be alive to the possibility that we could see a tipping point if bond yields continue to rise,” said Tim Evans at Citi Futures Perspective in New York.

“Everyone that decided they wanted to be long on gold or oil might decide it’s not worth it anymore. That’s the risk of investment bubbles driven by cheap money. It’s worth keeping an eye on interest rates as they creep higher and money isn’t as cheap anymore.”

Commodity traders have become used to looking at currency and equity markets for buy and sell triggers over the last five years after the influx of investment money “financialized” the formerly sleepy sector and created closer correlations with the broader economy.

By contrast, the bond market has been readily ignored on a day-to-day basis, but few dispute historically low yields have contributed to increased money flowing into commodities as investors seek out higher returns.

Analysts said that while the U.S. tax compromise could help stimulate economic growth — with Bush-era tax cuts extended for both middle income and high earning households for another two-years — the move has risked undermining confidence in the ability of the United States to juggle its debts longer-term.

The split was illustrated by a sell-off in U.S. Treasuries for a second day on Wednesday, driving yields to a six-month high. At the same time, the dollar rose on the perception economic growth could be bolstered.

Commodity prices have also been buffeted with prices violently changing direction several times on Tuesday and Wednesday as traders wrestled with the outlook.

For some, rising bond yields are a sign of economic strength rather than weakness.

Ed Morse, managing director of commodity research at Credit Suisse in New York, said concerns for commodity investment were “wildly premature.”

“My personal view is that the rise in yields is (also) anticipating stronger GDP growth in the United States rather than any concerns about deferred inflation,” Morse said.

“The good news is embedded in the rising yield,” he said, adding that stronger GDP growth in the world’s largest economy could be seen as nothing but bullish for commodities.

As investors have sold U.S. Treasuries, the yield on a 10-year note has risen sharply from around 2.5 percent in late November to a six-month high of 3.33 percent on Wednesday.

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Commodity prices have finished broadly flat since the U.S. tax compromise announcement late on Monday, with the Reuters-Jeffries index (.CRB: ) slipping by less than 1 percent.

Edward Meir, head of commodity research at MF Global in New York, said the rise in bond yields was not enough to divert investors from commodities toward bonds for now, but he still saw it as a negative omen for the sector that was pushing traders to the sidelines.

“If yields get back up to 4 percent or more, it could change the whole mentality,” Meir said.

“The whole cycle is this. If you get moderate inflation, then commodity prices should rise. But if interest rates rise to 4, 5 or 6 percent, then you risk tipping the economy back into a recession, which will be a larger negative than any influence from inflation. The question is this: ‘where is the inflection point?'”

Investors betting lower taxes will bolster the U.S. economy in 2011 have seen the dollar rise against the yen and hold slimmer gains against the euro.

A stronger U.S. currency tends to weigh on dollar-denominated commodities as they become more expensive for holders of other currencies.

John Higgins, senior markets economist at Capital Economics in London, said he thought the initial reaction was muted in commodities as prices have already risen strongly over the past two months.

“Valuations are not in bubble territory, but they do now look quite stretched,” Higgins said. “The big negative for commodities, however, has been the rally in the dollar. A further rise in the U.S. currency should push most commodities much lower still next year.”

Higgins said he does not expect U.S. bond yields to rise toward 4 percent, but he still expected the U.S. tax deal to ultimately push commodity prices lower.

Meir at MF Global was in agreement, saying that with many commodity prices close to their peaks for the year, this could be the trigger for a correction as traders take risk off the table ahead of the year-end bonus rounds.

“It’s not just the United States that is a concern,” Meir said.

“If China or Brazil raise rates again they’re going to slow their economies, which won’t be positive for commodity prices. “My best guess is that we’re in for a correction, possibly by January.”

(Editing by Steve Orlofsky)

Analysis: Commodity bulls, bears polarized by bond yield surge