Energy prices and supply constraints may keep commodities high for months

NEW YORK » Commodities prices have had some hiccups lately, seeing some down days after flitting near record highs for more than a year. Don't count on a big price drop to stick anytime soon: Some analysts say energy prices and supply constraints could bolster commodity prices for months.

"Load up your gasoline tank!" Merrill Lynch & Co. commodity strategist Francisco Blanch warned in a research note. He argues that while gasoline demand is dramatically higher, the United States has failed to increase gas storage capacity.

"Simply put, the U.S. petroleum products market has become too large and too complex for the existing storage capacity base," Blanch wrote. "As a result, we continue to believe that petroleum product price volatility will stay extremely high in the coming months."

But crude oil that has passed $75 a barrel and gasoline already selling for more than $4 at some service stations are only part of the problem. High energy prices worldwide affect other commodities, especially those that can only be processed using a lot of energy.

Take aluminum, which is trading at about $1.25 a pound, up about 50 percent from a year ago. Most aluminum smelters buy electricity using long-term contracts to hedge against price increases, but electricity futures are outpacing aluminum futures, Blanch wrote. Aluminum producers might consider becoming electricity as well as alumina purveyors.

"After adjusting for the price of alumina, we find that primary aluminum producers in various parts of North America would be better off by shutting down their plants, and then reselling the electricity and alumina separately into the market," Blanch wrote.

Aluminum companies' profits aren't necessarily hurting because of the higher energy prices, and their stock prices reflect Wall Street's satisfaction with the producers' efforts at cutting costs. Alcoa Inc. is trading near the top of its 52-week range, closing yesterday at $33.78, while Alcan Inc. is also at the upper end of its range, finishing the week at $52.26.

Of course, increasing global demand is also helping drive commodities prices higher. The commodities markets as well as Wall Street wobbled on Thursday on news that China was raising interest rates to cool its economy. But that same day Phelps Dodge Corp. predicted copper prices would average $3 during the second quarter; they're currently in the $3.50 a pound range, up $2 from a year ago.

A series of strikes has also constrained supply for some commodities. A zinc smelter strike in Mexico, a copper mine strike in Chile and a gold mine strike in Peru have all chipped away at production, said Frank Holmes, chief investment officer of U.S. Global Investors Inc.

Gold is at 26-year highs, trading yesterday at $655.55 an ounce on the NYMEX. Zinc, meanwhile, has risen more than 150 percent from a year ago, and is trading in the $1.60 a pound range.

Further constraining commodities production -- and in turn driving up their prices -- is the lack of investment during the 1990s. It generally takes 10 years following the discovery of oil or a mine before it's online, Holmes said, and if investment slows, the results can be felt the next decade.

For zinc, "recent reports of mine startups and reactivations, virtually unheard of in recent years, simply underline the urgency of the supply-side's response to growing demand," Citigroup Inc.'s metals, mining and commodities analyst, Alan Heap, wrote in a recent report.

While a handful of mines could be reopened "even if this new material was available now, our analysis indicates there is insufficient smelter capacity to process it," Heap wrote.

Another fact that's driving commodity markets is often overlooked: They just aren't that big.

Said Heap, "Net investment in physical gold was $11 billion worldwide in 2005, a rounding error compared to equity or fixed income markets."