Once raging commodity bull may be out of gas

Your Money

September 24, 2006

You'd be hard-pressed to find a "hot commodity" lately.

With the U.S. housing market giving investors a scare, China's building boom facing some restraint, Iran apparently less of an immediate threat to oil supplies, and hurricanes failing to howl, commodities have been slipping since early August.

Crude oil futures on the New York Mercantile Exchange have fallen more than 20 percent since reaching a record $78.40 a barrel July 14. Stockpiles are rising. And hedge funds reportedly have been growing more cautious about commodity bets since Amaranth Advisors LLC, a Connecticut hedge fund, made national headlines last week after a bum move in natural gas cost the company billions of dollars.

As the hurricane season passes without destruction, natural gas prices have slipped almost 70 percent from a record high of $15.78 per 1,000 cubic feet in December.

With each day, prognostications about commodities have been turning more negative. While the long-term view held by many analysts, including those at the Goldman Sachs Group Inc., is that this is a lull in a multiyear global growth drama, others are starting to warn investors that the five-year bull market in commodities may have run its course.

In a recent report titled "Whither Commodities," Morgan Stanley analyst Stephen Roach said: "For the second time in five months, commodity markets are coming under serious selling pressure. I don't think this is a fluke."

If the downturn becomes more than a short-term correction, the pain could be widely felt. Individual investors have grown fond of commodities, and new mutual funds and exchange-traded funds covering such commodities as oil and gold are an easy investment, even in some 401(k) plans. Pension funds, searching for alternatives to stocks and low-interest bonds, have developed an appetite for commodities.

"Just as return-hungry investors chased these markets on the upside, they could well run like lemmings to get out on the downside," Roach said.

Wells Capital Management strategist James Paulsen is warning investors to be leery of expectations for higher oil prices.

He said many investors believe that the decline in oil prices to just over $60 is temporary. But he noted recent events suggest otherwise. Just before Hurricane Katrina, oil was at about $70, and even a host of unnerving events - hurricanes, terrorist attacks, nuclear concerns about Iran and North Korea and pipeline problems - haven't propelled oil much over $70. Paulsen said that suggests a peak.

China has been the most significant driver behind the growth in commodity consumption between 2002 and 2005. But August data out of China point to some cooling, with industrial output up 15.7 percent versus 18 percent in June and July.

One month, of course, provides little evidence of a trend. But Roach said that if China's output growth slows to 12 percent to 13 percent, there would be a "major downturn in global commodity demand."

"As China slows and the U.S. property bubble bursts, a broad and protracted downturn can be expected in most economically sensitive commodity markets, including oil," he said.


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