Analysis: Current commodity rally more selective than in 2008

By Barani Krishnan and Claire Milhench

NEW YORK/LONDON (Reuters) – It’s simple enough to see that many of the world’s key commodities have surpassed their peaks from 2008, including gold, corn, and copper; others are still well behind, oil and wheat to name but two.

But the common theme is elusive: robust Chinese growth can help explain copper’s buoyancy, but is irrelevant for coffee; loose money policy has clearly aided gold, but done less for oil; the tightest stocks since the Great Depression have fueled corn, while wheat is far from its peaks.

The deviation suggests investors may have grown more selective than three years ago, focusing on market-specific fundamentals over a broad desire for diversified exposure to the sector. The fear, of course, is a return of the herd mentality behind the historic ride — and crash — of 2008.

These days, investors are more careful how they put their money to work, unlike three years ago when bubbling economies and euphoria over the rapid rise of China fueled a near indiscriminate explosion in raw material prices.

They worry about inflation like never before and challenge market data and forecasts. They try to exploit relative performance between assets in the energy, metals and agricultural space, to squeeze out a better return.

“The market is very selective at the moment,” said Fabien Weber, portfolio manager for the Julius Baer Commodity Fund at Zurich-based Swiss & Global Asset Management, which manages some $87 billion in client assets.

That commodity investors have become more selective is not a new theory, but the latest gains have but a line under it. Of the 19 commodities in the Reuters-Jefferies CRB index, only 10 are above their 2008 peak.

The best proof of the new approach could be in oil. Some of the most needed crude supply now is locked away in war-torn Libya. Even more is at stake from unrest stretching across the Middle East and North Africa.

Yet, oil prices remain well below record highs, with top exporter Saudi Arabia stepping in to fill the shortfall left by Libya. Comfortable crude stockpiles in the United States have also limited price gains in the No. 1 energy-consuming nation.

To match the 2008 high of above $147 per barrel, London’s Brent crude, now hovering at $125, needs to go up about 19 percent. U.S. crude, trading above $112, has to rise more than 30 percent.

INVESTORS HAVE LEARNT

Even if crude hits a new peak, some think it won’t hold. Many are now more leery of the potential for consumers to quickly respond to higher prices, with 2008 having put years of academic work on demand elasticity to test.

“We are long on energy, but we are certainly not long on crude,” said Hakan Kaya, who oversees commodity investments in a $1.8 billion multi-strategy fund at New York-based Neuberger Berman, which manages a total of $190 billion.

“I think people learnt their lesson from 2008. I don’t think they will let prices go above those levels,” Kaya said, referring to how commodity markets began correcting after the record highs in oil that year, even before the collapse of Lehman Brothers triggered the financial crisis.

Adam Sarhan of New York financial advisory Sarhan Capital echoes that view. “There are a few caveats, and none the greater than demand destruction, which can set in once people feel prices are getting too high for the economy’s good.”

A few commodities, such as gold and cotton, reached record highs well before this year and had been going even higher in recent months, weeks and days.

Yet, gold’s 43 percent gain since its 2008 peak is less than half of the near 91 percent seen in silver. At below $40 an ounce, silver has become the logical — and, possibly, smarter — precious metal of choice for the poorer investor.

Cotton, spared of such competition, has jumped more than 125 percent since its 2008 peak as the prospect of ultra-low U.S. supplies dawned on the market.

FOCUS ON FUNDAMENTALS/RELATIVE VALUE

In the broader agriculture arena, corn is barely above its 2008 high in spite of a new record. Coffee has, meanwhile, risen more than 60 percent from its 2008 peak and sugar 70 percent. That, to some, signals an imminent change in relative value trades.

“Softs are now very expensive relative to grains. You can see corn, soybeans and wheat starting to take off, leaving …sugar and coffee behind,” said Charlie Morris, head of absolute return at HSBC Global Asset Management in London.

In industrial metals, copper is 5 percent below a February record high, depressed by weak demand from top consumer China. Tin, which has a relatively small market to copper, is up 22 percent on the year and 216 percent since a bull run that began in April 2009 on inventory woes.

“I think there has been a bit of a switch out of copper and increasing exposure to tin,” said Nic Brown, head of commodity research at London’s Natixis. “Whether you are looking at very near term, or longer term, tin is looking very good.”

OLD HABITS, INFLATION COULD CHANGE THINGS

Despite the seemingly greater financial discipline, the lure of easy money — thanks to the billions of cheap dollars made available to investors since the recession began — means the old habit of chasing rallies may just return.

Fear of inflation also provides a legitimate excuse for more money to arrive into commodities.

One of the conventional wisdoms for investing in natural resources is that they are supposed to provide a hedge against inflation, when the dollar weakens for any reason. But the past few years have shown that, if anything, high commodity prices themselves were fueling inflation.

With the European Central Bank having fired the first round of global rate hikes this year — and the U.S. Federal Reserve sticking so far to its super-easy monetary policy — the dollar looks set to weaken further, prompting more people to see commodities as a hedge.

“What we’re seeing now is not just a function of conventional supply/demand dynamics,” said Dan Brebner, analyst at Deutsche Bank in London. “It’s a dynamic distorted by money supply and supply of dollars.”

(Additional reporting by Susan Thomas and Pratima Desai; Editing by Jonathan Leff and Lisa Shumaker)

Analysis: Current commodity rally more selective than in 2008