By Ranjit Behera
Commodities after having the run of their life have finally faltered. This market was historically created for the physical hedgers (like farmers, miners etc), where they could have market-based price discovery. This concept worked fine as long as transactions were carried out for hedging price risk. Slowly the market grew into prominence and caught the eyes of non-hedgers. This was the turning point of the market. In came a new set of players called speculators and market grew as if sky was the limit.

Till 2004, Global commodities market was dominated by gold and other precious metals. Agricultural products and base metals formed small part of the market. In 2002, gold and other precious metals constituted half of the trillion dollar market. The market saw rise in base metals and energy trading accounting for 70% of the market by 2004. Year 2005 added a new chapter to the commodities market, marking the emergence of new investor class in the market.



The new players included financial institutions, hedge funds and other players mainly interested in speculation. Commodity markets uniqueness made it an ideal asset class. Historically it has zero to negative correlation with equities and out performed most asset classes during the time of crisis (The current situation is an exception). This made commodities a good avenue to diversify risk and get decent returns.

From 2004, commodity market has grown from $1.7 trillion to $13 trillion in 2008; a whopping 750% growth in four years. Metals, energy products and agricultural products led the way. Gold and other precious metals market grew but, their growth was dwarfed in front of energy and metals. Energy products particularly crude saw a whopping growth and its prices more than doubled. Similar price rise were seen in other commodities too.

Rapidly rising prices attracted more and more investors. Commodities probably had entered into one of its biggest speculative phase. Piles of cash started flowing into the market pushing the market up and up. High prices already had started creating panicky among middle and poor classes of the world but, investors rarely indulge in social obligations.

Booming stock market made investors to divert small amounts (in billions) into commodities. By mid of 2008, the market finally ran out of gas and took a nose dive. Billions were eroded from the market and credit crisis hit investors pulled money from all possible avenues. This resulted in massive exodus form all markets including commodities and prices have plunged to 2004-05 levels. Gold which is considered to be a safe investment avenue during crisis has seen decent upside as many have parked their cash in bullions.

The market has steadied over past few weeks but, it will still take some time to recover from the mayhem. The market currently is range bound with most commodities prices fluctuating in a range. Market is mixed with good news and bad news giving no clear direction. Economies of Developed countries are shrinking, demand for metals and energy going down and forecast for near term future is gloomy. These factors are pulling commodities down. Whereas huge bailout plans with sizeable chunk targeted to increase spending and U.S. plan to buy $1 trillion bonds will infuse massive liquidity into the market. This will possibly result in inflationary phase in future which is good for commodity markets. In the short term, high liquidity levels may not be sufficient to lighten the dampened investor sentiments. Market is seeing minor rebound but, getting back to strong footing will take a while.

(Mr Behera is Analyst, Commodities and Emissions Markets, Celent, Bangalore(Financial Consultancy and Research)

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