LONDON (Reuters) - The dislocation between loose U.S. monetary policy and rising rates in emerging nations will lead to more volatility and even bubbles in commodities, particularly in precious metals, says French investment bank Natixis.
The excess liquidity coursing through the financial markets that developed economy central banks such as the U.S. Federal Reserve or the European Central Bank pumped out during the global financial crisis has been a major driver in the rise in commodity prices.
Low real interest rates, emerging central banks putting some of their massive dollar reserves into bullion and persistent concern over inflation have made gold one of the biggest gainers among the commodities complex in the last year.
“For us the market that has most bubble-like characteristics is precious metals. As far as the gold market is concerned, it’s a liquidity fueled bubble. One is low interest rates,” Nic Brown, head of commodity research at Natixis, told the Reuters Investment Outlook Summit.
Gold, which has risen by around 10 percent so far this year and which is set for an eleventh consecutive yearly rally, has also benefited from investors seeking an alternative place for their cash as euro zone debt crises, the Japanese disaster and global economic uncertainty rattled stocks, bonds and currencies.
“You have substantial rationale for higher gold prices. We describe it as a bubble. Central bank accumulation of reserves creates bubble, expansion of US liquidity creates more of a bubble. If you have continuation of high-powered money you have gold prices going up,” he said.
Since the Fed signaled it would resume buying government bonds to prop up the economy in late August 2010, gold has gained more than 25 percent, having hit a record $1,575.79 an ounce in early May, compared with a 22 percent gain in the S&P 500 index .SPX, which is currently around 2-1/2 month lows.
In spite of a recent soft patch of economic data, the Fed is widely expected to begin withdrawing additional liquidity measures, such as its quantitative easing program - dubbed QE2 -- which expires this month, over the course of the year.
“It may be a bit too early to suggest end of QE2 will see massive increase in interest rates and gold prices will collapse. Our base case is that within this liquidity-fueled bubble we’re closer to the end than the beginning,” Brown told the summit in London.
Natixis sees crude oil as being vulnerable to supply shocks, especially since violence in the Middle East and North Africa has cut 1.5 million barrels a day from Libyan output.
“It’s a problem. Can OPEC increase output? Or will demand have to contract in order to catch down supply? We think it will be a little bit of both,” Brown said.
The bank sees the price of Brent crude futures, currently around $115 a barrel, up 21 percent so far this year, peaking before subsiding to average $111 a barrel in the second half of the year.
Brown said he was less bullish on base metals then he has been previously and said China, the world’s top consumer of commodities, remained key, especially if a slowdown in economic growth should materialize.
“A Chinese slowdown is one of the biggest risks. Our base case scenario is there may be a small slowdown in China but we certainly do not expect a collapse,” he said, adding that a slowing in GDP growth to 5 or 6 percent could provide commodity markets with “a nasty shock.”
That said, constraints to supply of copper, used predominantly in power and construction, would likely support the price of the metal, which is currently down about 5 percent so far in 2011, but holding near its highest in a month.
The robust outlook for the global auto market, where China is the largest player, would support the demand prospects for any metals used intensively in that sector, such as aluminum in car body parts or palladium in catalytic converters, he said.
Even with the Fed set to tighten monetary policy, thereby boosting the dollar and possibly undercutting the appeal of some commodities, and the risk of slowing Chinese growth, Brown said there was still a compelling case for investors to buy raw materials.
The fact that commodities often move inversely to other asset classes can given investors an edge, particularly at a late point in a particular economic cycle.
“(Negative correlations happen when) global growth gets to the stage where rising commodity prices are negative for global growth,” Brown said.
Additional reporting by Natsuko Waki; Editing by David Cowell