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Commodities Corner SATURDAY, APRIL 16, 2011 Investors last week got a glimpse of the commodity rally's underbelly. Analysts refer to it as "demand destruction" or "demand response," and it's not a pretty sight. Crude oil fell almost 6% within a span of two days. Copper prices plunged 5.8% in the week, and corn lost 3.4%. Big swings in commodity futures are nothing new, of course. That's why for decades raw materials were considered too risky for retail investors. But note that recent selloffs came amid some tangible developments, be they tightening by China's central bank or a calming in the Middle East. This time, the selloff was driven by sentiment—by definition unpredictable and impossible to measure—personified by Goldman Sachs. The bank in an April 11 note recommended closing several long commodity positions, essentially giving the signal to investors to sell. High oil prices are the source of "near-term headwinds" for copper and platinum, which may translate as a "negative demand shock" for these metals, according to Goldman's commodity analysts. When prices of basic goods shoot off into uncharted territory, as many have already done, investors are left wondering how high is too high, and when do high prices cure themselves? While there's often talk of imbalances between supply and demand, what's often overlooked are the imbalances between supply and demand data. Relatively speaking, supply is easy to measure. Governments and companies count the barrels of oil that come out of the ground and bushels of corn that are harvested by farmers. What governments haven't been able to observe directly is demand. Even the U.S. Energy Department, whose figures are the clearest window into a country's oil markets, doesn't give a total number for oil demand. Instead, analysts use the total amount of oil products supplied as a proxy. Finding and recording every instance of what's known as "end-user demand"—that's every gasoline purchase at a fill-up station but also the petroleum component of new roads—would be a heroic and expensive undertaking. And that's just in the U.S. The picture in countries like China is more obscure because there's so little information about what goes on in the "demand" chain ahead of the end user. That's not even counting the purchases governments themselves are making in secret. Eventually, the state of demand gets rooted out. If demand falls and supplies stay the same, inventories by definition would rise. But again, there's often confusion about the actual size of stockpiles in much of the world, and even in places with reliable data, there's often a big time lag. By the time inventories start to make a sustained rise, the smart money has already booked profits. Goldman Sachs published another note on April 15, after market participants had already associated its name with the week's falling prices. The bank said commodity prices are likely to be higher a year from now, although they recommended an underweight allocation over the next three to six months. Referring to oil prices, Goldman is "increasingly wary that with prices back at spring of 2008 levels, we may be beginning to see signs of the sharp drop in demand that led to prices plunging in the summer of 2008." Investors, brace yourselves! http://online.barrons.com/article/...204702304576257170692977418.html
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