Declining commodities have further to fall, analysts say
NEW YORK » Commodities had a miserable third quarter and many on Wall Street say they have further to fall. That theory was bolstered last week as oil prices sunk to their lowest level for the year.
If commodities prices do sink further, it will be bad news for emerging markets and the investors who have poured billions of dollars into them over the past three years.
Commodities prices tend to have a domino effect -- lower oil prices often drag down gold prices, for instance. And lower commodities prices tend to push down stocks in emerging markets such as Russia and Brazil, countries with a rich supply of oil and metals, respectively.
While many emerging markets continue to be on a tear, if the commodity bears are right, there may be plenty of pain to spread around.
While investors pulled $263 million out of gold and natural resources funds for week that ended Oct. 4, they still have $26.9 billion in the funds, according to Bank of America Corp. Fund flows into emerging markets slowed during the same period, but investors still have $96.6 billion riding on emerging market funds, according to Bank of America.
Stephen S. Roach, Morgan Stanley's chief economist, wrote in September that the tidal wave of money that has flowed into commodities over the last three years has transformed commodities markets "from one of the best real-time gauges of economic activity" to a financial asset like any other -- that is, one that's susceptible to hysteria and bubbles.
"Just as return-hungry investors chased these markets on the upside, they could well run like lemmings to get out on the downside," Roach wrote.
Merrill Lynch & Co.'s chief investment strategist, Richard Bernstein, agrees, saying that cheap money and heavy borrowing inflated prices in commodities. Those prices are now 60 percent above what could be explained by fundamental supply and demand, he wrote earlier this month.
"These data suggest that September's downfall in commodities might only be the beginning of a protracted bear market," he wrote.
Other factors that pushed commodity prices higher, such as the U.S. housing boom and powerful growth in the Chinese economy, could also drive prices lower. A slowdown in the housing market is well under way and economists expect slower growth from China as well.
The decline in home construction has already hit the lumber market, where prices recently dropped to 5-year lows. Metals used in homebuilding, such as copper, are also facing price pressure.
Roach argues that a downturn for U.S. consumers could slow business for Chinese producers. U.S. consumers continue to gobble goods made in China, which is why the U.S. trade deficit with China was a record $22 billion in August. But if American consumers were to start cutting up their charge cards, the effects would be felt in Chinese factories almost immediately.
Less use in the U.S. auto industry should affect steel, aluminum, glass and rubber demand, wrote Tobias Levkovich, Citigroup Inc.'s chief U.S. strategist.
While the argument for continued high prices for commodities is that demand will continue to grow, Levkovich points out that there's some room for supply to grow, too, with a possible increase in Saudi oil production and a recent Chevron Corp. find in the Gulf of Mexico.
If the strategists are right, investors who have seen impressive run-ups in markets such as South Africa, where stocks are up more than 25 percent for the year to date, might consider taking some money off the table -- and away from all the other dominos.