A commodities sell-off is bringing a sudden chill to financial markets where investors were already turning cautious about the prospect of a slowdown in China and other emerging economies given steady monetary tightening. Silver and crude oil saw a dramatic plunge in the past week, registering record single-day falls on Thursday.
Oil has lost as much as 17 percent in the past week alone, while the broader Reuters-Jefferies CRB index, a global commodity benchmark, dropped more than 8 percent, on track for its biggest weekly fall since July 2008.
While moves are seen more driven by unwinding of speculative positions rather than a sudden reappraisal of the otherwise favourable global economic outlook, they are enough to prompt investors to scale back their risky bets.
The coming week brings key data and events for China, whose series of policy actions to curb inflation raised jitters growth momentum is slowing in the world's second largest economy. The China-US strategic and economic dialogue kicks off on Monday, with data on trade balance, inflation, industrial production and retail sales all due later in the week.
Emerging stocks, measured by MSCI have erased almost all of their gains since January, while their developed counterparts have fallen more than 3 percent from their three-year peak set in the past week.
"We see high correlations between equities and commodities, due to a demand effect coming from emerging economies, and that's contributing to a general move towards a defensive stance," said Christoph Riniker, strategist at Julius Baer.
"It will be difficult for equities in the next few weeks and we may have a prolonged period of sideways trading before the market picks up again. But we don't expect a huge sell-off given there's a lack of opportunities in other asset classes.
China has raised interest rates four times and banks' reserve requirements seven times since October, when it declared that it would make fighting inflation a priority.
Beijing has also allowed the yuan to rise against the dollar by guiding it towards successive record peaks. Many expect the yuan to post steady gains throughout this year.
Central banks in Korea, Chile and Poland are expected to raise interest rates in their policy meetings in the coming week, joining Russia and India which have already raised the cost of borrowing in the past week.
Equities are increasingly moving in tandem with commodities, with the 60-day rolling correlation between the CRB index and MSCI world equity index moving to 0.7, its highest since July 2010, from a recent low of 0.1 posted in March. Thomson Reuters' Lipper data showed funds that focus on metals, resources and energy took a hit in the week ended May 4.
The gold and natural resource funds had net outflows of $729 million, the most in net redemptions since the week ended September 2, 2009. Energy sector funds had outflows of $723 million, a reversal from the $343 million inflows in the prior week. Over the past week the economic data flow has turned less positive, with global surveys showing manufacturing growth in the United States and China slowing in April.
"Commodity markets have a tendency to cascade because speculators are positioned simultaneously, creating a rush for the exit," said John Ventre, portfolio manager at Skandia Investment Group.
"For real money investors a soft patch in data is not significant enough to warrant significant asset allocation changes. I would come back to neutral see if opportunities appear over the summer."
Growth momentum in export-driven economies such as Germany might also turn lower given the dollar's recent decline to a three-year low, at a time when inflationary pressures in the eurozone stand at a 30-month high.
Goldman Sachs said the S&P 500 index has not fully reflected the recent downshift in the macro picture, saying that a short-term correction to the 1,275 area was possible.
"As the recent data suggest, if we are no longer in a period of accelerating growth and if the data continue to point to a slowing cycle, a short-term tactical index correction would not be hard to envisage," Goldman said in a note to clients.
J. P Morgan has taken profit on its aggressive longs in equities within its model portfolio given the impact of growth downgrades, while it stayed net long on stocks.
"The earnings surprise phase is now completed and attention is likely to shift to the economic data flow. Any remaining downside growth risks are not enough, though, for us to turn flat on equities as we do believe that much of recent economic weakening will turn out temporary."