Analysis: Commodities poised to ride central bank cash higher

NEW YORK/LONDON (Reuters) - Commodities could extend a rally that has lifted prices more than 10 percent since late August, if central banks pump billions more dollars into the global economy to prop up the sputtering recovery.

Raw materials prices surged after U.S. Federal Reserve Chairman Ben Bernanke said on August 27 the Fed was prepared to use “unconventional” policies such as buying more long-term securities to drive down interest rates, if necessary.

“Increasing liquidity in money markets invariably finds its way into commodity markets. Anticipation of higher liquidity is already supporting oil markets as can be seen from the impact of the Japanese action,” said Credit Agricole energy analyst Christophe Barret.

The Bank of Japan on Oct 5 cut its benchmark interest rate to zero and pledged to step up asset purchases to help the struggling economy. Many economists expect similar action by the Fed.

U.S. crude oil futures broke through to a two-month high that day, extending a rally that has taken them out of a five-month trading range between $70 and $83 a barrel.

Industrial metals also surged in the wake of the speech, led by copper’s 13 percent rise, despite the economic weakness prompting central banks to mull another round of unconventional monetary policy they call “quantitative easing.”

Gold has smashed records in recent weeks as investors piled into the yellow metal to protect themselves from weaker currencies, expected to decline as the quantitative easing policies essentially amount to printing money.

“The fact that (quantitative easing) debases currencies is good for gold, the fact that it raises the prospect of inflation is good for commodities in general,” said David Hufton, managing director of PVM Oil Associates in London.

In the first round of quantitative easing sparked by the collapse of Lehman Brothers, the Federal Reserve pumped $1.7 trillion into the economy, buying various credit instruments.

The action reflated asset prices, contributing to a 15 percent annual gain in oil and similar gains in copper and precious metals, according to Bank of America Merrill Lynch.


Upward pressure on commodities is not solely due to flows of funds, many analysts say, pointing, to capacity constraints that sent prices soaring this decade before the U.S. housing bubble burst and the world’s top economy slid into recession.

“Although capacity utilization remains depressed in many sectors of the economy, capacity utilization in commodity sectors -- mining and petroleum in particular -- are at or above pre-crisis levels,” Merrill said on Thursday in a research note titled “The Liquidity Supernova”.

The next round of quantitative easing, which many financial professionals refer to as QE2, could well lead to big price gains in capacity constrained sectors and will likely lead to gains even if it fails to stimulate broader economic growth.

“The introduction of QE2 should provide great support for commodities prices even if demand stays weak,” the Merrill research note said.

Heavy bets on commodities as a proxy for macroeconomic conditions have already changed pricing in many futures markets. Future deliveries of many commodities now cost more than prompt delivery, a condition known as contango that quantitative easing is likely to exacerbate.

“You may see a huge amount of futures buying which means there’s perhaps greater demand for long-dated futures contracts and less demand, at least initially, for the physical markets ... but that should moderate and reverse going forward after the QE becomes effective in stimulating actual demand,” argued Deutsche Bank analyst Daniel Brebner.

Liquidity should bolster agricultural commodities over the longer term as well, noted grain markets analyst Jeff Thompson of ABN Amro.

“General inflation worldwide will take us up,” he said. “It is just going to (provide) an underlying buoyancy.”

Central banks in big food-importing emerging markets like Mexico are already taking note of rising food costs. The Mexican central bank added grain prices to its list of inflationary pressures it was monitoring in its latest monetary policy statement last month.

Still, there is a risk that heavy speculation in commodities could undermine the recovery that investors are betting on. Some say a surge in raw materials prices could squeeze consumers and hurt the commodity-dependent emerging market economies currently driving world growth.

Also, quantitative easing is no sure bet. Bernanke has promised to use the policy only if necessary and with policymakers warning of currency wars if a sharp devaluation of the dollar exacerbates global trade imbalances.

“It’s a financial shell game and in the long run I’m not sure anyone wins,” said Jason Schenker, head of Prestige Economics in Austin, Texas.

“It could stimulate the markets and add a bit of inflation into the mix but if they do too much the size of the Fed’s balance sheet will ultimately lead to questions about the Fed’s credibility.”

Additional Reporting by Marie-Louise Gumuchian in London and Mark Weinraub in Chicago; Writing by Robert Campbell; Editing by David Gregorio