Commodity price rally not the recovery signal many believe

PUBLISHED : Tuesday, 09 June, 2009, 12:00am
UPDATED : Tuesday, 09 June, 2009, 12:00am

The rally in Hong Kong stock prices so far this year has been impressive.

But equally impressive has been the rebound in global commodity prices. As the first chart below shows, the S&P GSCI index of commodity futures contracts has actually pipped the Hang Sang Index over the year to date, climbing 29.4 per cent to the Hang Seng's 26.9 per cent.

Commodities might seem a distant concern to service-dominated Hong Kong, but the rise in commodity prices has had some important consequences. The vigour of the rebound, based largely on continued buying from the mainland, has bolstered investors' belief in China's economic recovery. At the same time, it was partly the renewed strength in commodity prices which prompted shareholders in Rio Tinto to oppose the company's planned sale of shares and assets to Chinalco.

Yet although the surge in commodity prices has had far-reaching effects, some observers are beginning to question whether the rally - like the rise in stock markets - might have run dangerously ahead of economic reality, and to wonder if prices may now be primed for a nasty fall.

The first point to note here is that not all commodities are equal. As the second chart below shows, performance this year varies widely between them. Copper, for example, is up by 63 per cent, while crude oil has risen just short of 21 per cent.

Gold on the other hand is up a relatively meagre 10 per cent, while aluminium is up by a paltry 2 per cent.

Clearly different forces are driving different commodities. According to industry sources, copper has risen so strongly because China's State Reserve Bureau has been buying heavily to amass a strategic stockpile of the metal. This makes good sense, as Beijing's stimulus spending involves large investments in the mainland's electricity transmission and distribution system which needs large quantities of copper.

The State Reserve Bureau is also buying aluminium, but for an entirely different reason. After massive investment in smelters over recent years, the mainland now has the capacity to produce around 18 million tonnes of aluminium a year. Even with all of Beijing's stimulus efforts, however, Chinese demand is expected to be only around 12 million tonnes. The state is buying up some of the surplus production to support the industry, but industry insiders believe the overhang will continue to weigh on prices for years.

The price of oil, meanwhile, has been supported in part by speculative hoarding in anticipation of rising demand with economic recovery. Research house GaveKal estimates that 100 million barrels of crude oil and another 30 million barrels of refined products are sitting idle on tankers waiting to come to market. While this is positive for prices in the short term, past experience suggests that should the prices begin to slip, a lot of that oil could get dumped on the market at once, further depressing prices.

And then there is gold. Although widely touted by enthusiasts as a hedge against future inflation, gold has struggled relative to other commodities so far this year, with much of its price rise in US dollar terms attributable to the greenback's weakness against other major currencies. In terms of sterling, for example, gold is flat over the year to date, while in Australian dollars it is down a touch. Inflation, it seems, remains a distant prospect.

In all, it appears that the recent rise in commodity prices may not be quite the indicator of recovery many investors would like to believe. Rather, the run-up has been driven largely by state and speculative stockpiling; stockpiling which is unlikely to be sustained if the recovery fails to materialise as soon or as strongly as expected.