herd mentality takes hold of commodities

http://today.reuters.com/business/newsarticle.aspx?type=tnBusinessNews&storyID=nL27636019

ANALYSIS-Herd mentality takes hold of commodities





By Clare Black and Barbara Lewis


LONDON, May 4 (Reuters) - Once a disparate group of small, illiquid markets, commodities are now a cohesive asset class, where big jumps on one exchange can ripple through the sector.


Last week conflicting news on interest rates caused gold, oil, copper and even sugar prices to fall in tandem and then rally together in a kneejerk reaction.


Fears about Iran's nuclear ambitions have also driven widespread buying since the start of the year, but the biggest single factor is China and its huge appetite for all raw materials.


"We notice oil has been rallying at the same time as copper and gold," said Deborah White of SG CIB in Paris. "That, we think has to do with the funds."


For others China is the more significant unifier.


"It's more to do with China," said Kevin Norrish of Barclays Capital. "I think if you go back and look for any major announcements out of China, you will see big moves."


Analysts predict the markets will continue to interact.


China's demand shows little sign of ebbing and investment and hedge funds increasingly view commodities as an indispensable way of diversifying a portfolio, meaning traders are more likely to look at a range of markets.


"Everything is much more correlated between the different markets. Five years ago you could trade crude oil by itself. Today you have to keep an eye on other commodities, forex, equities," said Olivier Jakob of Petromatrix consultancy.


Reverbations from the commodities market have triggered big changes in equities.


On April 21, when oil and other commodities surged to records in response to fear of possible U.S. military action against oil producer Iran, Britain's leading sharing index the FTSE 100 <.FTSE> hit a five-year high as mining and oil company stocks climbed.


There is a downside.


"The danger in that is that all markets start to be much more linked one to another and a severe correction in one market can bring a snowball correction," Jakob warned.


Other commentators have likened the speculative inflow into the sector to the dot.com bubble in 2000. [nL03461737]



SUPERCYCLE


But a lot of the new money in commodities looks set to stay.


A major reason is chronic underinvestment in infrastructure with the result commodities supply could struggle to meet demand for the foreseeable future.


"We are seeing a commodity supercycle," said Francisco Blanch, head of commodity research at Merrill Lynch.


"The price signals are telling us there is no spare capacity, the global economy is continuing to grow quite strongly and we really need to start investing very heavily in this sector."


Apart from fundamentals, many investors, such as pension funds, lock in for the long term, mainly through indexes, which group together a variety of raw materials.


(For factbox on performance of various indexes and main commodity movements, click on [nL04784646])


Indexes are still favoured by newcomers, but those with a bigger appetite for risk are seeking out other approaches, which are adding to the new momentum across the commodities markets.


"The investors are getting more and more mature in the asset class itself and looking at taking some of the alpha out the market," said Frederic Hervouet, head of sales at Diapason Commodities Management, a Swiss-based firm that has a range of commodity funds.


The quest for alpha, or returns generated by an active rather than passive trading position, has spawned new investment tools, some of which are changing price structures by pushing money into contracts for later, rather than prompt delivery.


"It will increase liqudity further down the curve," said Norrish of Barclays Capital. "Certainly, it is an element of buying that was not there before."


The switch to electronic trade has also had some impact.


Last year, the London oil trading pit closed, making base metals the only commodity traded through open outcry in London, though the United States still uses pit trading for oil and many other commodities.


Screen-trading can make it easier for traders to dip into a range of commodities.


"Now any trader can open a futures account. It's the democratisation of the market," said Jakob.







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