The rise in commodity prices over the past two years has been nearly unprecedented. Fueled by low interest rates, a weak dollar, strong foreign demand, the use of ethanol and countless other factors, billions of dollars flowed into commodity futures and commodity index funds over the past two years.
Many large buyers, especially pension funds, hedge funds and mutual funds, have invested large sums in commodities in order to better allocate their portfolios as well as capture some of the outsized gains.
Because of the massive inflow of money and the seemingly unending march to higher and higher prices, it should come as no surprise that the money would eventually come back out. It would appear as though we've now begun to see the beginning of exactly that.
Though many commodities have seen price increases that are far out of line with underlying fundamentals, it appears as though buyers may have finally realized that the rally was overdone. Since July 3, the CRB index, the benchmark for the broader commodity market, has fallen 13 percent from its high. That is an astonishing move for a market-wide index.
One of the largest components of that fall is the energy market. Since July 3, crude oil has fallen about $22 per barrel, or 15 percent. Gasoline prices are off by an astonishing 58 cents per gallon, or 16.1percent. Natural gas, the biggest loser of them all, is off by an amazing $4.50, or 33 percent.
The cause of the fall is the shift in viewpoint. For months, traders pointed to tight supplies and production numbers that weren't increasing enough. As crude moved from $100 to $148 this year, the argument was the same n supplies are tight. At the same time, fundamental data continued to show exactly the opposite. Huge drops in demand, especially in the U.S., starting showing up in the weekly data as early as May.
Mild weather kept natural gas demand low throughout much of the spring and summer. Retail gasoline prices over $4 and higher prices on everything from jewelry to milk to beef finally caused consumers to drive less.
After three months of dismal data, the energy market finally took notice and started focusing on the demand side. As long as the focus remains on demand and the demand data remain weak, energy prices may have a hard time rallying.
Another huge loser this month has been the grains market. Crop prices soared this spring after farmers were prevented from planting their fields due to excessive rain. They soared even further in June after floods wiped out hundreds of thousands of prime acreage in Iowa, Missouri and Illinois.
The final piece to the perfect storm n hot summer weather n had the potential to cause huge yield losses and drive prices to unbelievable levels. Fortunately for farmers, the hot weather is still nowhere to be found. July has proved to be a nearly perfect month for growing crops n warm days and nights followed by rain every four or five days.
As a result, the selling pressure that was already building because of the general commodity liquidation was magnified by extremely benign weather. Corn and soybean condition ratings have steadily improved over the past six weeks and yield forecasts may have to be raised.
As a result, prices have nosedived. Since July 3, corn is off by about $2 per bushel, or 25.4 percent. Soybeans are off by $2.80, or 17.1 percent. These crops are certainly not out of the woods yet. An overly hot August or an early September freeze could wreak havoc on yields. But for now, there is little bullish news to push prices higher.
Walt Breitinger is vice president of commodities at Wachovia Securities. He can be reached at (219) 738-6460.
