Prices for copper and oil are poised to fall, according to a new report that adds to the growing skepticism around the great commodity revival.
Kevin Norrish, a widely followed analyst with Barclays PLC, warns that raw materials prices could get trampled if the buyers who have piled into the commodity sector during recent weeks decide to simultaneously rush for the exits.
"Investors have been attracted to commodities as one of the best performing assets so far in 2016," he said. "However, in the absence of any concerted fundamental improvements, these returns are unlikely to be repeated in the second quarter, making commodities vulnerable to a wave of investor liquidation."
He says oil, now above $38 (U.S.) a barrel, could easily tumble to the low $30s, while copper might swoon from its current level of about $4,945 a tonne into the low $4,000s.
If so, the declines would mark a dramatic reversal of the recent burst of enthusiasm for commodities. Mr. Norrish estimates that more than $20-billion flowed into commodity investor products during January and February, the strongest start to a year since the boom times of 2011.
The frantic buying in the sector since mid-January has fuelled the "biggest commodity comeback ever" after a dismal 2015, according to Jodie Gunzberg, global head of commodities and real assets at S&P Dow Jones Indices. Nearly all metal prices have surged over the past two months, while oil prices have risen more than 40 per cent since mid-February.
One force driving the rebound has been growing optimism that China is not going to slide into a severe economic slump or aggressively devalue the yuan. China accounts for nearly half of global consumption of many industrial metals so its prosperity is key to commodity markets.
Another encouraging factor has been a softer tone on the part of the U.S. Federal Reserve Board, which is now taking a slower, more cautious approach to raising interest rates than many observers had expected late last year. The prospect of lower-for-longer rates has boosted the outlook for gold in particular, since the precious metal provides no yield and tends to do best when after-inflation rates on competing investments are low.
In the case of oil, the rebound appears to reflect slowing production in the United States as well as signs that the world's major producers may be willing to freeze output to support prices.
However, most analysts have remained skeptical of the commodity revival, especially when it comes to metals. Goldman Sachs and Citigroup have both issued dour forecasts that stress the ugly fundamentals that continue to plague the mining industry. In just about every area, supply continues to outrun demand.
Mr. Norrish of Barclays concurs and points out that some key markets have been pushed so fast and so far that they could violently recoil.
"Key commodities markets such as oil and copper already face overhangs of excess production capacity and inventories, but also now face another obstacle in the recovery process, that of positioning, which is now approaching bullish extremes," he said.
The risk is that many investors may decide to extricate themselves from those bullish positions at the same time. Their simultaneous rush for the door could cause prices to crash.
Mr. Norrish says the odds of that happening are relatively high, because many recent commodity buyers appear to be short-term speculators rather than buy-and-hold investors.
Commodities have been one of the few areas to generate strong returns in the first quarter, so institutional investors in particular may feel pressure to exit their positions and lock in profits as the quarter ends.
Adding to the danger is the risk that the U.S. Fed may become more hawkish in the weeks ahead.
If so, the prospect of higher U.S. interest rates would likely boost the U.S. dollar. That would be bad for commodity prices, since most raw materials are priced in terms of the greenback. A stronger U.S. dollar makes them more expensive to international buyers and typically dampens demand.
Mr. Norrish says commodity prices could slide 20 to 25 per cent in a worst case. "Steeper declines would probably require a significant change in the mood music of the global economy, with the biggest threat being the potential for another build-up of concern over a possible [Chinese yuan] devaluation."