Commodities Bottom as Speculators Vanish After Slump

By Millie Munshi

Sept. 22 (Bloomberg) -- The worst may be over for commodities after the steepest rout since at least 1956 drove out speculators and the U.S. government unveiled a plan to end the worst credit-market seizure since the Great Depression.

The Standard & Poor's GSCI Index of commodities had the biggest three-day gain in 18 years, surging 8.4 percent through Sept. 19, the day U.S. Treasury Secretary Henry Paulson said the government will spend ``hundreds of billions'' to cleanse banks of mortgage-related assets. Crude oil rose 6.8 percent that day, while wheat and copper gained 3.6 percent.

``What the government just did is the end game, and it's going to mean a good rally for commodities,'' said Michael Pento, a senior market strategist who helps oversee $1.5 billion at Delta Global Advisors in Holmdel, New Jersey. ``Six weeks ago, I thought it was prudent to exit most commodities. Now you want to own these things. I'm jumping in twice with both feet.''

Commodities, which had the best first half in 35 years, tumbled so far this quarter as the combination of slowing economic growth and the strengthening U.S. dollar popped the speculative bubble that drove prices to record highs. The Reuters/Jefferies CRB Index of 19 raw materials is down 22 percent since June 30, heading for the biggest quarterly loss since at least 1956, data compiled by Bloomberg show.

Speculators Sell

Hedge funds and other large speculators sold U.S. commodity futures tracked by the CRB. Excluding nickel and aluminum traded in London, so-called net-long positions, or bets prices will rise, dropped 72 percent since July 1 to 241,370 contracts on Sept. 16, data from the Commodity Futures Trading Commission in Washington show.

Investors pulled a net $3.9 billion from commodity and energy funds since mid-July, money-flow tracker EPFR Global, based in Cambridge, Massachusetts, said in a statement Sept. 19.

The CRB rose 2.4 percent the day of Paulson's announcement and the MSCI World Index of stocks rose 5.7 percent, the biggest gain in almost 21 years. The index increased 0.7 percent today.

The plan by Paulson and Federal Reserve Chairman Ben S. Bernanke would purge banks of devalued mortgage-linked assets, after earlier efforts failed to revive financial and housing markets. The government took over American International Group Inc., Fannie Mae and Freddie Mac in the past two weeks, a period when Lehman Brothers Holdings Inc. filed for bankruptcy and Americans withdrew a record $89.2 billion from money-market funds.

More to Come

``We're probably going to see a really prompt recovery of the U.S. economy in the fourth quarter or early 2009,'' said Michael Aronstein, president of New York-based Marketfield Asset Management, who correctly predicted in June that commodities would fall. ``I've been bearish on commodities since the second quarter, but we could certainly get a rally for a few months for many of these markets.''

The U.S. rescue plan ``won't be the end'' of the crisis, Aronstein said. ``You'll still see tighter liquidity conditions, and in the developing markets there are still structural problems. Commodities will probably bounce for two to three months, but you're not going to see them at record highs.''

Not everyone expects commodities to rally, because economic growth remains sluggish. The U.S. economy will grow 1.5 percent next year, down from 1.7 percent this year, according to a survey of economists by Bloomberg.

``It seems pretty clear we are in a recession or heading there, and ultimately that spells soft demand and lower prices,'' said Tom Knight, a trading director at Truman Arnold Cos., an independent fuel wholesaler in Texarkana, Texas.

Price Increases

Commodities may rise anyway because Paulson's plan will pump more cash into the economy, increasing the chance of accelerating inflation, said William Fordham, president of C&S Grain Market Consulting in Ohio, Illinois.

Consumer prices will likely accelerate 4.5 percent this year, according to a Bloomberg survey of analysts. The U.S. may have to borrow an extra $700 billion to $1 trillion to fund the rescue, according to Michael Pond, an interest-rate strategist at Barclays Capital Inc. in London.

``Everything that has happened this week is inflationary in the long run,'' Fordham said in a Sept. 19 e-mail. Government efforts to ``support Wall Street'' and keep stocks from falling are ``long-term bearish for the U.S. dollar and extremely inflationary for commodities.''

The CRB posted its best first half since 1973 as the dollar sank toward a record low against the euro, and the index reached a record on July 3. The U.S. currency rebounded 11 percent against the euro since touching the low on July 15, prompting investors to unload commodities.

`Crazy Money'

Commodity markets are ``oversold,'' and the ``bull cycle'' for energy and raw-materials producers ``is far from over as severe supply constraints that have led to high and rising prices in recent years remain intact,'' strategists at Goldman Sachs Group Inc., the largest of the remaining independent U.S. securities firms, said in a report last week.

The GSCI Index of 24 commodities should return 17 percent in the next 12 months, Goldman strategists led by Allison Nathan said. The index is down 26 percent since the end of June.

The decline was ``all about this crazy money flow that gripped all the financial markets,'' said William O'Neill, a partner at Logic Advisors in Upper Saddle River, New Jersey. ``We could start to see a shift in the flow.''

Open Interest Falls

As of Sept. 17, open interest in commodity futures tracked by the CRB, excluding aluminum and nickel, was down 12 percent this quarter, data compiled by Bloomberg show. Open interest, the total number of contracts yet to be closed, liquidated or delivered, is a measure of what direction money is flowing in commodity markets, O'Neill said.

Inflation prospects make commodities more appealing than equities, said Christoph Eibl, who helps manage more than $1 billion of commodities at Tiberius Asset Management AG in Zug, Switzerland.

``It's not time to panic'' in commodities, Eibl said. ``There are a lot more problems in the banking sector, in the real economy. Commodities have already taken a serious hit. There are other assets in the portfolio you have to worry about.''