Commodities prices may be resurging after last month's modest hike in US interest rates but risks from the broader economy and within markets are not over, sector experts said on Wednesday.
"Commodity markets are now at a critical juncture," Citigroup Research, a division of Citigroup Global Markets Inc, said in a report released this week. "Tighter monetary policy is the dominant risk. Further interest rate hikes would not only slow commodities demand growth, but more importantly, curb investor interest in this sector," it said.
Other concerns include a possible weakening of the US economy if the local housing market slowed to a point of weighing on consumer confidence, and stagflation - which is a combination of weaker growth and higher interest rates.
Commodity prices appear to be moving back in the direction of May's highs after seven weeks of edginess over world growth prospects, fund managers said this week.
Key metals such as copper and gold have added about 6 percent to prices since the end of June, although they remain around 15 percent below the peaks of May.
The markets found their footing when the US Federal Reserve raised short term interest rates on June 29 by just 25 basis points to 5.25 percent - after psyching investors for weeks into thinking there may be a 50 basis-point hike.
The Fed also said it will watch inflation closely to decide if there should be a further hike in rates in August. Up till then, for two straight years, it gave no sign of backing off from high rates to mop up a flood of easy money that had rushed into various assets classes, including commodities.
The softer Fed stance came amid higher US economic growth in the first quarter - 5.6 percent versus estimates of 5.3 percent - and bolstered investor confidence further.
But Citigroup said it expected the Fed funds target rate - a measure of short-term interest rates - to reach 5.5 percent by September after another revision in August. It said research showed that interest rates at just over 3 percent were sufficient to curb both growth and commodity prices in general.
"Thus, we are approaching the critical juncture at the short end of the curve, although the long end is still some way away." Citigroup said for the time being, it saw continued support for commodities from a "Goldilocks world" - where economies grew at a just right pace without being too hot or cold.
Nevertheless, it anticipated specific threats to substances such as copper as prices rose. "Copper is the base metal most sensitive to substitution, and pressures are increasing," it said.
"More recently, we have identified substitution in wire markets - winding wire, underground cable and even building wire - in addition to copper tube. The main substitute in wire markets is aluminium."
In a separate commentary, US money manager Bridgewater Associates, which has about $150 billion under management, said the Fed has been wrong since last year in expecting inflation to ease along with the slowdown in housing. So the same may apply to its latest outlook on interest rates, Bridgewater said.
"When the Fed suggests something...it tends to get priced in because the markets tends to believe it. So, the best way to make money is to have an independent view of the forces that will drive what the Fed will do and bet on that view, not the Fed's innuendos," Bridgewater said. Goldman Sachs said in another outlook on metals markets that macroeconomic uncertainty was high despite the current pace of global activity.
"The increased uncertainty over future economic growth, despite firm current activity, has in our opinion resulted in higher metals price volatility which has then been magnified by low levels of metals inventories," it said.
Goldman Sachs said the long-anticipated slowdown of the US housing market will hurt demand for copper and other metals, but added that this will be offset by continuous growth in Chinese, Japanese and European demand.
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