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Dubai: Commodities prices could face a reversal in the medium term, upsetting both institutional as well as individual portfolios, according to research by Merrill Lynch and Societe Generale.
With the exception of a few base metals, prices of commodities hit record highs recently. While oil is trading above $100 a barrel, gold topped $1,000 an ounce this month before retreating. Agricultural commodities, too, are at historic highs.
"The question is whether this escalation is sustainable. Since last summer, there would appear to be a certain element of disconnect between commodity markets and physical fundamentals," said Michel Martinez, an analyst with Societe Generale Asset Management.
A fund manager survey by Merrill Lynch showed 25 per cent of respondents overweight in energy stocks, up from 19 per cent in February. Martinez said that in the short-term, until the current financial crisis has been resolved, it is likely that this trend will continue and that commodity prices will be underpinned at high levels by persistently strong investment flows. In the medium term, fundamental considerations should move back to the foreground and a correction is possible.
Francisco Blanch, head of global commodities research at Merrill Lynch, said: "The big question for investors is how long they can depend on commodities and commodity-linked stocks to deliver attractive returns. While commodities enjoy a good short-term outlook, inflation poses a medium-term risk to the asset class."
Over the last year, the performance of most asset classes has been lacklustre. In contrast, commodity prices have literally exploded with a year-on-year increase of almost 60 per cent in dollar terms across the board.
Out of sync
Economists say these price movements are out of sync with fundamentals. Since China entered the WTO, the commodities cycle has been coupled with the industrial development of emerging markets.
However, the link has become looser over the past few months as industrial production in Asia has recently not accelerated. On the other hand, they say the strong financial investment flows explain the recent trend in commodity prices.
A trend reversal is probable once visibility on the financial system and on the state of the US economy is restored, according to Martinez.
Positive developments on this front are unlikely before the second half. For the time being, markets are not discounting a continued escalation in commodity prices (futures attest to the fact). However, upside risks remain high.
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