Commodities correction to draw in fresh investors

LONDON (Reuters) - Oil and metals markets are undergoing a correction that fund managers say could take some prices down by 10-20 percent, but the long-term uptrend seems intact and a fall is only likely to draw in more investors.

Many of the investors who missed out on the commodities rally early this year are preparing to enter those markets for the first time or add to their holdings.

The notable exception is grains and other agricultural products, where relatively illiquid markets, previously populated by consumers and producers, have made it difficult for funds and to invest large amounts.

Overall, however, across the commodities complex, prices could fall by 10 to 20 percent over coming weeks and months as short-term players take profits or cut their losses.

"In the last stages of an upswing you get a lot of short-term investors and traders coming into the market, who don't care about fundamentals," said Ashok Shah, chief investment officer at London & Capital.

"The underlying fundamentals will reassert themselves."

One of the tenets underlying the bull run of the last few years has been demand growth from emerging countries such as China and India, with their growing middle classes and massive amounts of money allocated to infrastructure.

Unless the United States falls into deep recession, which would damage export-reliant economies, commodity demand from these countries is something investors cannot afford to ignore.

That is a major reason why many institutions such as pension funds are still making new allocations to commodities and why new funds dedicated to the sector are still being launched.

And in oil and copper -- used in power and construction -- there is the ever-present worry over supply, often triggered by disruptions, politics or stockpiling.

VIOLENT CORRECTIONS

Crude oil hit a record peak above $135 a barrel on May 22 and is now at around $128 a barrel, copper MCU3 on the London Metal Exchange hit an all-time peak of $8,880 a tonne on April 17 and has since fallen about 10 percent.

Part of the reason behind those falls has been the firmer dollar, which makes commodities priced in the U.S. currency more expensive for holders of other currencies.

After European Central Bank president Jean-Claude Trichet said on Thursday euro zone rates could rise as soon as July, the dollar sell-off boosted oil and gold prices.

But if markets take to heart the change in tack at the U.S. Federal Reserve whose chairman Ben Bernanke this week shone the spotlight on inflation, the dollar could stage a significant recovery and accelerate the retreat from commodities.

"Markets don't go up in a straight lines," said Kevin Arenson, chief investment officer at Stenham Asset Management.

"We could see violent corrections, but ultimately we are still in a bull run that will last for another 5 to 10 years."

The reduction of subsidies on commodities such as petrol in places like India could also hit crude sentiment as higher prices could erode demand in the short term.

Spot gold XAU=, down about 15 percent from a peak above $1,030 an ounce touched briefly on March 17, is also likely to see a fallout from a resurgent dollar as the precious metal has the strongest relationship with the dollar.

Investors use gold as a hedge against financial uncertainty, which often manifests itself in a weaker dollar.

However, allocations to gold -- as a store of value -- are rising with concerns about inflation, which erodes wealth, and prices towards the end of the year could be heading back up.

DILEMMA

In agriculture, the dilemma for investors is liquidity.

"Agriculture is an area we are watching closely because we have some concerns about the amount of capital flowing in," said Kimberly Tara, chief executive at FourWinds Capital Management.

Much of the money heading for that market is long-only -- buy and hold -- a far cry from the days when most deals, between 80 and 90 percent, were done between consumers and producers.

"Long only money is fine in a large market like corn or oil and gas, but in the smaller agriculture markets (tropicals, meats, fibers) it could be very difficult to digest," Tara said.

Doubts about liquidity combined with expectations of higher crops is probably why European wheat BL2c2 has tumbled about 35 percent to 188 euros a tonne since February.

To get round the problem, to diversify exposure and bolster returns many investors, especially institutions such as pension funds, are turning to farmland.

A recent example is a fund being launched by UK-based Emergent Asset Management, which will buy farmland in Africa and manage it through a joint venture with a local company.

(Additional reporting by Barbara Lewis; editing by Christopher Johnson)