Commodity Consensus

MarketBeat : Commodity Rebalancing Rally Tails Off

Commodity Rebalancing Rally Tails Off
Posted by David Gaffen

OilThe recent rally in commodities, particularly the metals and grains, is in part the result of expectations for the rebalancing in major commodity indexes that will increase the weight of certain commodities, such as copper and live cattle. But as the rebalancing takes place over the next few days, analysts are skeptical of the recent surge due to the sour outlook for the world economy.

The price of copper, oil, and other major traded commodities have rallied sharply of late. But it comes in the face of a poor economic outlook. “Given the outlook for the economy over the year, I’m not getting overly excited about owning commodities,” says Stephen Schork, publisher of the Schork Report, a newsletter on the oil and gas industries.

Wednesday, commodities were pulling back, losing some of the recent gains. March copper futures fell 6.10 cents to $1.522 per ounce, while corn was down 8.25 cents to $4.1925 a bushel, and the volatile crude oil contract was off by $3.70 to $44.88. Oil and copper (the commodity with the economics degree, as it is said) have moved with a greater degree of correlation with equities of late, as asset managers take positive moves in stocks to indicate a better feeling about the economic outlook, and apply those expectations to commodities (and vice versa).

The Dow Jones-AIG Commodity Index’s new weightings become effective by January 15. Crude oil will rise to 13.8% of the index, from 13.1% in January of 2008. However, J.P. Morgan Chase analysts estimate that losses in oil during the year have dropped its weighting now to about 9.6%, so the re-weighting is providing quite the boost. Copper, meanwhile, will rise to 7.3% from 4.5%.

Copper has been buoyant over the past 10 days.

The Standard & Poor’s/Goldman Sachs Commodity Index shows similar effects. Crude’s weighting will rise to 33.8% from 32% at the end of December; it was 38% at the beginning of 2008, but declined as oil declined.

“Investors do want to have the ability to be ready to take advantage of a future rally in commodities, and you have to reflect it in your positions,” says Bart Melek, global commodity strategist at BMO Capital Markets. “But we’re in a holding pattern — we have to see what happens with a stimulus package, and certainly what happens in China.”

While commodities might ease off in the early part of the year, if the Federal Reserve succeeds at re-inflating the economy through the various efforts to pump money into the financial system, it could benefit raw materials such as copper and other metals, says Michael Hoeft, CEO of Panacea Capital Management. For now, however, he says hedge funds have not finished liquidating positions, and that may pressure commodities.

“I think we’re going to see a bout of deflation and once that’s over, then we’ll see hyperinflation,” he says. “There’s a deflationary bent to the economy that will keep commodities kind of in a range…but then we’re going to see major hyperinflation.”

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