Commodities expected to play catch-up

While commodities have held up relatively well in recent days, in comparison with their related stocks, analysts say that could change if the market freefall continues.

"It is not unusual for falls (or rises) in the prices of commodity-related equities to be of a different magnitude to falls (or rises) in the prices of the commodities themselves. But over time, relative price fluctuations have tended to come out in the wash," John Higgins, senior markets economist at Capital Economics, said in a recent report.

Mr. Higgins points to the summer of 2008, on the eve of the global market meltdown, when a drop in commodity-related equities became a leading indicator for the decline in commodities a few months later. Back then, the price of such metals as copper, nickel and coal fell by more than half.

"In other words, the prices of commodities were slow to react to the new reality. We think a similar development may be taking place today," he said.

A drop in commodity prices has huge implications for Canada's resource driven economy, given its massive oil reserves, second only to Saudi Arabia, as well as its dominant position as a producer of zinc, uranium, gold and other metals alongside key global agriculture products such as wheat and potash.

Commodity prices have bounced back since the last recession, and in some cases hit new highs earlier this year. However, mounting debt concerns in the United States and Europe and the gradual gearing down of China's economic engine have caused prices to pull back.

Last week's market dive pushed prices down further, but not as much as the companies behind the commodities. For instance, while copper fell about 7 per cent over the past week and zinc 10 per cent, companies that produce both, such as Teck Resources Ltd. (TCK.B-T41.62-1.28-2.98%) and Lundin Mining Corp., (LUN-T5.33-0.34-6.00%) saw their shares fall by about 12 and 25 per cent respectively on the Toronto Stock Exchange.

The world's largest mining companies, BHP Billiton Ltd., (BHP-N79.14-1.10-1.37%) Rio Tinto plc (RIO-N59.19-1.41-2.33%) and Vale SA (VALE-N27.98-0.81-2.81%) have each seen their shares fall between 14 and 16 per cent over the past week in New York. Rio fell the most, even after reporting on Thursday record profit for the first half of the year.

Commodities are being dragged down alongside other sectors as stock markets fall, wiping trillions off the value of global equities. The turmoil comes as investors fret over the ability of some of the world's wealthiest nations to handle their crushing debt loads.

There are also concerns that China, whose appetite for commodities helped pull the mining sector out of the last recession, will dramatically reduce demand as it tries to solve it own economic problems.

China is raising interest rates to try to ease growth and tame inflation, but there are worries such a slowdown could come faster and cut deeper than intended. That would have negative implications for economic growth around the world.

Investors will be looking for more clues on China's economic health this week, when the country reports key data for July on inflation, retail sales and industrial production. Trade figures also due to be released will show whether Chinese exports continue to weaken alongside slowing global demand.

"We are becoming quite concerned about the near-term outlook for China," GMP Securities analyst Matt Fernley said in a report.

"With the U.S. consumer starting to roll over, we are concerned about the outlook for exports, but with China currently in a tightening cycle, we are not sure what strategy they can adopt."

In particular, high Chinese inflation is being driven by food prices, not materials, Mr. Fernley said.

"As a result we are concerned that if China continues too far with its tightening cycle, it may engineer a near-term hard landing."

Analysts are considering a downward revision of their commodities forecasts now that prices have slipped in recent days, with Capital Economics forecasting a sharp drop in oil prices and a weakening of industrial metals such as copper and zinc.

"Only some precious metals are likely to escape," Mr. Higgins said.

Gold, considered a safe investment in troubled times, is expected to keep shining after continuously setting new records in recent weeks. Its latest was a record $1,684.90 an ounce reached Thursday in New York.

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