Soft commodities yoked to stocks for now

By Marcy Nicholson - Analysis

NEW YORK (Reuters) - Coffee, cocoa and sugar prices have been joined at the hip to global equity markets since September in an unusual dance sparked by the worst financial crisis in 80 years, but the relationship should dissolve by early next year.

Futures prices for these commodities -- known as softs -- typically have not been tied to stocks and bonds. Instead, factors such as crop growing conditions and the balance of supply and demand drive the softs markets. Currency fluctuations also have an influence.

But such fundamentals were overshadowed recently as big investment funds liquidated their positions across all markets, including commodities, in the economic meltdown since the summer.

The global economic downturn rippled through markets around the world following the collapse of the U.S. housing market. Investors bailed from markets to meet their financial obligations, such as increased margin requirements.

Although the strong U.S. dollar also forced some investors out of commodities, softs previously had never been so tied to stock markets, said Rob Kurzatkowski, futures analyst for optionsXpress in Chicago.

Hedge funds, which rode the "commodity train" up for much of the year, were forced to liquidate positions to make their margin calls and free up capital, Kurzatkowski said.

In mid-October, global stocks dove to five-year lows as panicked investors sought refuge in cash. Following stocks, coffee slid to a 17-month low, cocoa dropped to an 11-month low and white sugar hit a 10-month low.

"Most of the selling isn't coming from fundamental sellers making a fundamental decision that the market isn't worth what it was," said Shawn Hackett, president of Hackett Financial Advisors in Florida.

"It's more entities who are getting massive margin calls in other assets that are being forced to sell some soft commodities -- not because they want to but because they have no other choice," Hackett added, calling the situation short term.

"What's going to happen at some point, maybe even in the next three or four months, you're going to start to see the de-coupling of the markets again," Hackett said.

However, soft commodity markets will remain attached to stock market fluctuations at least until the end of 2008, if not into February, Kurzatkowski said.

"Downside pressures remain for both equity markets and commodity markets. We're still in deflationary mode, at least for (the) near term," he said.

"When the equity market actually begins to show signs of life, it will probably kind of separate itself from the commodity markets, and you'll probably see commodity markets lag a little bit behind," he said.

Until then, fund liquidation will keep pressure on the markets, said Rodrigo Costa, vice president for institutional sales for Newedge USA in New York.

"If they are reducing their long positions across equities, for instance, they have to do the same for commodities, otherwise they're going to have much higher portion of their investments in commodities than others," Costa said.

(Editing by Walter Bagley)