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Make hay while you can

Like Wile E Coyote, the Loony Tunes cartoon character who could run on thin
air even after he had run out of cliff, commodity prices have seemed to defy
gravity.

But since mid-July many have come crashing down to Earth. The fall has been
led by oil, which has dropped from a record $147 a barrel in the US to below
$100 within the space of two months.

Other industrial commodities have shown similar falls. According to London
Metal Exchange data, aluminium fell 18% to $6,900 a tonne, nickel is down 11% at
$18,500 a tonne and zinc down 10% at $1,700 a tonne. The Economist industrial
commodities index is down 20% in dollar terms since its peak.

This has brought cautious optimism to central bankers, especially in the UK
and Europe, who had refused to cut interest rates because of fear of further
inflation.

But for some companies, such as XL Leisure, Britain’s third largest tour
operator that went bust on 12 September, the fall in oil was too little, too
late.

“The huge fuel price hike and the inability of the business to hedge all its
fuel has increased our costs year-on-year by more than $80m,” XL Leisure
chairman Phil Wyatt says. “So where many people have been making hay with high
oil prices, this is the repercussion of that hay ­ 1,700 people potentially out
of work today in the UK.”

Commodity speculators have been blamed for the doubling in oil prices since
last summer. But analysts believe other factors are at play, both on the way up,
and the way down.

Strong economic growth in emerging economies, especially China and India,
supported demand and prices for raw materials even as western economies were
slowing.

As Paul Tucker, an executive director at the Bank of England says, “Part of
the rise in commodity prices over the past few years is explained by a profound
structural shift as the world economy is joined by large, rapidly developing
economies which are increasingly energy intensive.”

Since the middle of the year the slowdown in rich countries has intensified,
with the UK and parts of the continent on the brink of recession.

Slower demand
Emerging economies have also started to slow. “In what appears to be a shift in
sentiment, weaker supply and demand fundamentals are asserting themselves,” the
International Energy Agency said in its September monthly oil report.

To that can be added a rebound in the dollar. The currency’s low-point on 15
July coincided almost exactly with the peak in oil. Sterling-based buyers
haven’t had all the benefit of the fall, then.

Analysts think prices may start to rise again and that this fall in commodity
prices will turn out to be a blip in a long-term super-cycle.

Kona Haque, senior commodities analyst at Macquarie Bank, says she is
“bearish-ish” on metals in the short-term because of the slowdown in demand.
However, she points out that for metals such as aluminium the price is now close
to the cost of production, which will prompt producers to shut down.

“Medium term, I expect prices to rise in 2010,” she says. “China may weaken a
little bit, but I can’t see it being suppressed for long.”

Meanwhile the decision on 10 September by OPEC to cut crude production may be
an attempt to put a floor under the price.

Stephen Lewis, chief economist at Monument Securities, says: “If the fall in
the oil price is just another correction in a rising trend, now is the time when
the oil price should be expected to establish a base.”

Haque, who earlier this year forecast oil at $200, admits the climate is
bearish, but says there is little sign of an increase in supply.

“Two months ago we were $50 away from $200 and ultimately oil is a finite
resource,” she says. “It is still on the cards but not just not in the short
term.”

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