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THE 'SEATBELT' SIGN IS STILL ON IN COMMODITIES

Expect another volatile year. But global demand should fuel the markets

Through much of 1996, commodity-trading adviser Steve K. DeCook was close to hitting the jackpot. In September, his futures fund was up as much as 12% as his bullish bets on corn and soybean prices finally started paying off. Then came the harvest surprise: Better-than-expected yields pushed prices sharply lower. As farmers were filling their bins, DeCook's profits were slipping away, and he ended October down 4%. By December, his $95 million fund had clawed back into the black--but only by a few percentage points. ''It has been a year full of unanticipated twists and turns,'' DeCook explains.

Expect much the same in 1997. Day-to-day trading activity will be fast-moving and unpredictable. Grain markets could continue falling, and booming energy markets could run out of steam, sending overall commodity prices lower for a time. Over the long term, though, the trend is bullish: Robust demand will probably lead to higher prices in coming years. Recovery in Japan and Europe will pick up the slack from a slowing U.S. economy, and East Asia will continue growing. On the supply side, inventories of many raw materials will remain relatively tight, supporting higher prices. ''The basic direction for commodity prices is upward. This is a great place to be,'' says Michael E. Metz, chief investment strategist at Oppenheimer & Co.

INFLATION JITTERS. This may not auger well for the New Economy, though. Even in an era of low inflation, gyrating raw-materials prices can spark inflation scares. That can put pressure on the Federal Reserve to boost interest rates. And should a crisis rock the globe, the sky is the limit for hard assets: ''If we have a civil war tomorrow in Russia, raw-material prices will rise significantly and financial assets will collapse,'' predicts Stefan Judisch, a vice-president at Union Bank of Switzerland.

As always, each market has its own peculiar hot buttons that can drastically affect prices. In the short term, broad trends can take a backseat to everything from rainfall in Des Moines to copper stockpiles in Rotterdam. Certain markets will be especially sensitive to news, including crude oil, natural gas, and other energy contracts, which were a hot play in '96. A spike in global economic expansion could send aluminum and other industrial metals higher. Cattle prices could move ahead by the end of '97 as the impact of a recent feed shortage plays out. Even the grain and soybean markets that so confounded DeCook and other commodity bulls could see plenty of action if Mother Nature plays tricks on the Corn Belt.

In energy markets, which over the past year have seen their most explosive trading since the Persian Gulf War, watch for tall peaks and deep valleys again in '97. Crude oil traded as low as $19.46 per barrel in June before roaring to $25.92 on Oct. 21. After a quick retreat, crude for January delivery rebounded to close at $25.74 as of Dec. 16. Inventories of heating fuels remain so depleted that the market is acutely vulnerable to demand shocks. To keep up, ''refiners are going all-out,'' notes analyst Ann-Louise Hittle of Cambridge Energy Research Associates Inc. in Cambridge, Mass. She expects energy prices to stay relatively high in the first quarter, especially if unusually cold weather strikes the U.S. and Europe.

The biggest check on rising energy prices will be booming production. One key factor: the scope of Iraq's return to the crude-oil export market under an oil-for-aid scheme approved on Dec. 9. Prices could come under pressure if the U.N. allows Iraqi barrels to flow in bigger-than-expected quantities over the next year. While OPEC isn't expected to change its quotas, new production is coming from the North Sea, North America, and Venezuela. Still, demand is so robust that even a big gush of supply may not force down prices: ''It will be soaked up,'' Hittle predicts.

Production is much more sluggish for industrial metals, and that's bullish for prices. Aluminum already has started reacting to forecasts of a widening production/consumption deficit in '97. The outlook for lead is similar, says Derek S. Van Eck, manager of the Van Eck Global Hard-Assets Fund. Copper's outlook is more akin to oil's: tight inventories now, but higher production on the way. Through much of '97, copper will be vulnerable to supply shocks--for example, mining problems at a major producer such as Chile. And Sumitomo Corp. will be a wild card as it repositions in the aftermath of its $2.6 billion copper-trading scandal last summer.

Precious metals will be less exciting. Gold is dead in the water--and likely to stay that way. Only runaway inflation, a U.S. stock-market crash, or some other cataclysmic event will break prices out of their narrow trading range of $370 to $400 in '97. One potential drag on the market is European monetary union. Gold bugs worry that European central banks might sell official gold reserves in advance of currency unification. Gold producers, too, appear ready to sell if prices move higher. The psychologically significant $400 level will be difficult to top, says David J. Rinehimer, director of futures research at Smith Barney & Co. Silver and platinum have more upside potential, he says, because producers aren't selling as aggressively, central-bank divestitures aren't an issue, and industrial use is likely to advance.

CAFFEINE FITS. For a wake-up call, traders should watch the coffee market in '97. As producers have held back production to keep prices up, consumer stockpiles have tightened steadily. Going into the new year, inventories were lean in the U.S., Europe, and Japan, where the most coffee is quaffed, and January futures prices were at $1.25 per pound as of Dec. 16.

But that could change soon: The harvest of high-quality beans in Mexico, Central America, and Colombia was getting off to a strong start as of mid-December. Robust production could push prices down to $1 or so in the next couple of months, says Smith Barney's Walter Spilka, a softs-commodity analyst. After the first quarter, the market will focus on the Brazilian harvest in July and August. Since coffee bushes tend to produce a smaller crop the year after a big crop is harvested, Brazilian production likely will drop from 27 million bags in '96 to 25 million or so in '97, Spilka believes. That smaller yield could thin out stockpiles, sending prices back up in the second half.

The cocoa market has the opposite problem: Inventories couldn't get much bigger. At $1,362 per metric ton as of Dec. 16, cocoa prices are relatively low compared to other commodities as well as historical price ranges. The bargain has spurred greater consumption and discouraged producers from maximizing their crops. Key African producers Ivory Coast and Ghana will reap smaller harvests in '97. As consumption exceeds production and world stockpiles tighten, cocoa prices could test $1,700 in '97, Spilka predicts. One ''softs'' market that won't see much action: sugar. Abundant supplies and steady demand will keep prices between 10 cents and 11 cents per pound, Spilka says.

GHOST HERD. Among other agricultural products, weather will be an even bigger factor than usual because supplies remain relatively tight. The cattle market could be affected if frigid temperatures this winter put additional stress on a lean supply of animals. Already, traders have seen cattle prices shoot higher after steep feed costs in early '96 cut into breeding stock. ''We liquidated an awful lot of cows,'' says analyst Dan A. Vaught of A.G. Edwards & Sons. He expects prices to ebb from current levels early in '97, then rise again as supplies dry up.

As for the grain markets, some believe the current downturn in prices is likely to last. Weather conditions in key Midwest growing areas have been favorable, with good moisture levels. Farmers in the U.S. and abroad are expected to plant ample acreage. And technology--notably, new hybrid seed--is expected to boost yields. Unless the '97 crop runs up against bad weather, prices won't climb much higher, says Richard J. Feltes, director of commodity research at Refco Group Ltd.

Yet DeCook, for one, is not convinced. He suspects that the U.S. Agriculture Dept. overstated the harvest numbers in its key October crop report, especially for soybeans. Since global demand is growing along with incomes and population, when the market recognizes that supplies aren't as bountiful as supposed, prices will rise again, DeCook says. Come what may, traders will be spending a lot of time and money trying to gauge how much corn will grow, oil will gush, and copper will shine in '97.

By Greg Burns in Chicago



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