Fresh surge in commodity prices raises fears of unsustainable speculative bubble

Fears of an unsustainable bubble in commodity prices were fuelled yesterday after key industrial metals such as copper and zinc surged amid thin trading.

The copper price leapt more than 3 per cent in London as traders returning from the Bank Holiday rushed to catch up with a strong increase in New York on Monday.

It jumped by $235, or 3.4 per cent, to $7,235 a tonne compared with Friday's close. Zinc rose $135, or 4.3 per cent, to $3,310 a ton, within sight of the record of $3,445 hit last month.

The increases were scored against very thin trading in the absence of buying from China and Japan, the major consuming nations that begin week-long holidays this week.

"If the natural buyers go away you would expect the market to come off a bit but it's not happening - it shows you that it's a financial market, not a market between physical sellers and physical buyers," one fund manager said.

The International Wrought Copper Council (IWCC), a trade association for copper users, has written to the Financial Services Authority and the London Metal Exchange (LME) warning about the increasing role of speculators.

Simon Payton, its secretary general, said the price had been driven up by a "feeding frenzy" by hedge funds. "It may be great for the producers but we feel that a market built on speculation leaves tremendous problems for out side of the industry," he said.

"The margins on metal is straightforward, so at $3,000 a tonne, it is just about bearable but $7,500 a tonne raises serious issues."

The LME refused to discuss either its conversation with the IWCC or the reasons for the rise in prices. A spokesman said: "The market is operated in an orderly and transparent fashion and we have mechanisms in place to make sure that that is the case."

The copper market is prone to speculation as it is essentially a fast-moving financial market placed on top of a physical market with considerable lags between the mine and the open market.

Last winter, copper prices surged to a then-sedate $4,115 a tonne on rumours that a Chinese state copper trader had taken out a huge bet that prices were set to fall - and then went missing when prices soared 30 per cent.

However, analysts believe commodities are being driven by fundamental factors. On the one hand, supply is being held back by a number of constraints. On the other, the meteoric growth in countries such as China, India, Brazil and Russia - the foursome dubbed the BRICs by Goldman Sachs - is driving demand.

As Barclays Capital said in its recent forecast update: "Very few natural resource companies possess either the opportunities or capabilities to swiftly raise their output to keep abreast of the sustained move up in demand growth."

A survey by Barclays of 200 of its investor clients, including banks, pension funds, mutual funds and hedge funds, showed a massive shift into commodities. While more than two-thirds had no position in commodities at the end of 2004, the same proportion forecast that they would hold at least 6 per cent of the portfolio in these physical assets.

Whether this is speculation or sensible investment is open to debate but the figures appear to show that even conventional investors have woken up to the fundamental forces driving the price.

With the US equity market posting a 6 per cent gain in 2005 and US bonds rising 7.8 per cent, according to ABN Amro, committed commodity investors look wise.

There was fresh evidence of strong demand for copper on Monday from figures showing that US spending on construction rose twice as much as forecast in March, and a snapshot survey of the industry showed hefty expansion in April.

The metal is used in infrastructure projects for electrical wiring and piping. Copper also goes into a wide range of manufactured export goods such as fridges, computers and mobile phones.

Copper had gained 59 per cent this year and zinc, used as an anti-corrosive coating in galvanised steel production, had jumped 66 per cent.

Even the gold price, which hovered below the record of $661 an ounce set last week, is being driven by fundamental factors, analysts said.

Ross Norman, a director of thebulliondesk.com, said: "There is always a danger in saying that 'things are different this time' but there are some fairly compelling reasons that we are seeing a once-in-a-century, or perhaps even longer, rise in demand for resources - perhaps since the Industrial Revolution."

He said that while issues such as rising inflation and geopolitical tensions had helped push up prices, it was easy to overlook the mismatch between supply and demand.

Production in South Africa is at its lowest since 1924, development of new mines is being slowed by new social regulations while Latin American governments are turning increasingly nationalistic towards their natural resources.

On the demand side, there are signs that investment and pension funds are looking to increase their positions. At the same time, demand has been spurred by the creation of exchange traded funds that allow investors to buy almost directly into gold. On top of that, the creation of exchanges in places such as India and Dubai has increased the ease of investing.

Mr Norman said the ratio of the oil price per barrel to the gold price per ounce - traditionally between 13 to 15 - showed that gold could be worth $950 an ounce.

"Gold has underperformed relative to other commodities and is playing catch-up," he said. "There are lot of people looking to get in at the bottom whenever it falls, which shows the character of the market."

The role of speculators has also been a matter of heated debate between consumers and producers in the oil market. Crude prices have surged seven-fold, from below $10 a barrel during the 1998 Asia crisis to almost $75 a barrel in recent days.

Western countries have blamed Opec, the producers' cartel, for withholding supply and being opaque about the volume of reserves and production. In return, Opec states have blamed the high and volatile oil price on hedge funds.

Strong global growth, especially in China, has led to a surge in demand for the "black gold". Meanwhile, the slump in prices at the end of the last century provided little incentive for the investment in exploration and refining, creating supply problems now.

On top of this, growing tension between the UN Security Council and Iran over the regional superpower's nuclear ambitions and mounting civil unrest in Nigeria has raised concerns over supply disruptions.

Mohammad Hadi Nejad-Hosseinian, Iran's deputy oil minister, raised the temperature further yesterday, saying there was "some possibility" of a US attack on his country. He said prices could hit $100 a barrel by the winter.

US oil rose 50 cents to $74.20 a barrel, while London Brent crude gained 21 cents to $74.10 yesterday.

Don't blame us for what is happening, say hedge funds

The hedge fund industry looked to pour cold water yesterday over a growing chorus of malcontents blaming it for the "super spike" in the price of commodities.

A letter from the International Wrought Copper Council to the Financial Services Authority and the London Metal Exchange claimed speculators were driving prices to levels that no longer reflect supply and demand.

The trade body echoed the sentiment of Lord Browne of Madingley, the chief executive of BP, who last week decried hedge funds and speculators as the engine driving soaring oil prices.

He said: "The increase in prices has not been driven by the fundamentals of supply and demand. It is the case that the price of oil has gone up while nothing has changed physically."

BP's head of supply and trading, Vivienne Cox, said trading in oil commodities by hedge funds had increased tenfold over the past five years. Certainly, the hedge fund industry is booming and managers are increasingly active in commodity markets, which have proved extraordinarily profitable for a handful of funds, both here and in America.

In recent months, the UK funds Armajaro Holdings, Winton Capital and Red Kite Management were among those to have done nicely from winning bets on copper alone.

But the hedge fund industry insisted that commodity prices were being driven by a range of factors - an increasing diversification into alternative assets by the traditional big investors; the voracious appetite for raw materials from China, Japan and India; low stockpiles; disruptions to production - and not simply speculation.

Fred Demler, who manages the base metals desk for Man Financial, said: "Fundamentals are driving prices. There's a view that we are in a commodities 'super cycle'. Sure, the hedge fund community has grown, but 95 per cent of hedge funds have no exposure to commodities."

Commodity markets were too big and too liquid to be cornered by any single class of investor, hedge fund managers said.

Gary Parkinson

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