Firmer dollar unlikely to upset commodities

By Pratima Desai and Barbara Lewis - Analysis

LONDON (Reuters) - A crumbling dollar helped spur this year's commodity price surge, but a rebound in the U.S. currency now does not mean necessarily that prices of industrial metals or oil will fall.

Increasingly the focus is on tightening supplies of raw materials and on escalating demand, particularly in China, India and other emerging economies.

The only commodity expected to come under significant pressure from any further recovery in the dollar is gold, which is used as a currency substitute and a financial instrument in much the same way as stocks and bonds.

"The reason why the gold price has not gone up despite the rise in the oil price is because the dollar strengthened," said Stephen Cohen, managing director at fund firm Troika Dialog.

Gold is often used as a hedge against inflation, which is often triggered by rising oil prices.

"Other commodities are different, they are going to be a function of their own supply and demand," Cohen said. "There are problems with mines in South Africa and in Chile, problems with oil in Nigeria and declining output in Mexico and Russia."

These difficulties coupled with perceptions that the Organization of the Petroleum Exporting Countries has little spare production and expectations demand will stay strong, boosted prices to a record of $126.98 a barrel on Tuesday.

"People have realized how inelastic global demand is in a period when supply capacity is not increasing," said Bob Greer, executive vice president at PIMCO.

The dollar is trading at around $1.54 to the euro. It hit an all-time low against the euro beyond $1.60 on April 22, a move fund managers said was overdone because other markets were already starting to price in a correction.

Spot gold is down more than 15 percent since peaking at $1,030.80 an ounce on March 17. But benchmark London copper has lost about 7 percent since touching a record high of $8,880 a tonne on April 17.

SOME JUSTIFICATION

The influence of the weak dollar behind rising commodities higher has been partly because these markets, once the province of producers and consumers, have been invaded by traders and investors speculating on short-term trends.

Used to reacting to economic data, they have seized the idea that a weaker U.S. currency makes commodities denominated in dollars cheaper for holders of other currencies.

Sustained dollar weakness also means producers with dollar revenues and local currency costs try to protect profit margins by raising prices.

"For me, the correlation between the weakening dollar and strength in commodity prices does have some justification," said David Dugdale at MFC Global Investment Management.