London - Commodities trading activity is set to stay choppy until the markets' conundrum--whether or not signs of recovery lead governments to cut stimulus packages too early--is resolved.
This is leaving data, which has exceeded expectations in most instances, to rule the roost. But the problem is that the pendulum of positive sentiment generated from recent U.S. manufacturing and home sales figures, for instance, just as swiftly swings back the other way when attention returns to the possible end to state-led support programs.
"Investors remain more concerned that the widespread signs of recovery generated by all the recent Purchasing Managers Index releases will lead governments to cut economic and fiscal support too early, a fear that has contributed to a reversal of prices right across the markets," said Alex Heath, global head of base metals at RBC Capital Markets.
Just this week, PMIs in a host of countries, including the U.S., China, the U.K., South Africa and the euro zone, posted increases, indicating that major economies are slowly returning to growth. The surveys show the percentage of purchasing managers in a certain economic sector that reported better business conditions than in the previous month.
With sentiment skittish, prices have been reacting accordingly. Copper has been extremely volatile of late, moving over 5% in the course of some trading days. Nickel has fluctuated by 6%, aluminum by 5% and zinc by 7%. Iron ore and cocoa have meanwhile both moved around 3%, while crude oil has traded in a nearly 6% range on a single day.
There are, of course, other factors that drive commodity prices, including their own underlying fundamentals, investor appetite for commodities, the U.S. dollar and improving equity markets. But the bigger picture remains dominated by the longer-term growth story, and how sustainable it'll be once government aid is withdrawn.
Undeniably, the size of the various stimulus packages has been unprecedented, as the world's governments tried to prop up their economies in what has been widely deemed the worst economic crisis since the Great Depression in the 1930s. For industrial metals like copper, zinc, nickel and aluminum, used in a range of applications including construction, housing, steelmaking and automotives, this support has been critical.
"The world economy has certainly been given a massive push in the right direction through sizable, sustained, and what looks like successful policy stimulus," said Gerard Lyons, chief economist and group head of global research at Standard Chartered Bank. "The questions now being asked are, how sustainable is growth? And how soon can policy be tightened?"
China, the world's largest consumer of commodities, has been heralded as the "savior" of the copper market through the first half of the year, as its government embarked on a strategic commodities stockpiling program at the same time as pushing trillions of yuan into the economy in various investment forms.
These include investment in the auto and home appliance industries and an increase in the supply of credit, which has supported rapid growth in fixed-asset investment and property.
According to Tao Wang, head of China economic research at UBS Securities, while China won't withdraw its government stimulus in 2010, the contribution of stimulus-related fixed investment to gross domestic product growth will drop significantly. "We see a modest global recovery to turn export growth from a sharp decline this year to a single-digit growth next year," he said.
There's also concern over China's buildup of domestic inventories, the restarting of domestic coal and iron ore mining, and narrowing price differentials between China and global markets, which have closed down arbitrage opportunities, analysts said.
Similarly, across Asia data has been improving for several months: South Korea has seen its economy rebound with three successive quarters of growth. But despite improvements elsewhere--Australia was the first nation to start tightening monetary policy as demand for exports leapt and its economy substantially improved--the picture isn't quite so strong.
"It's not possible for Asia to boom if the West is not booming. The trouble is that Asia is still heavily export-dependent," said Standard Chartered's Lyons.
This is especially true for the U.S., China's most important export market for finished and semifinished products. The world's largest economy posted impressive growth of annualized 3.5% in the third quarter, spurred by China's stimulus package.
Western nations have embarked on commodities-intensive programs such as car scrappage schemes, which have provided support for platinum--used in automobile catalytic converters--and aluminum--used to make car parts. But those programs are now coming to an end, and traders said any improvements in the demand and supply picture are tentative.
This hasn't stopped commodities prices pushing higher, however; it's just made the markets more volatile.
"The markets seem to cling on to positive news and react accordingly, which means there is a real incentive for many investors to keep pushing prices higher," said London-based Michael Khosrowpour of Triland. "Volatility in the markets is evident as signals of the status of the major economies are derived--interim highs in metals have been witness to vicious pullbacks," he said.
Consequently, commodities players say they'll be paying close attention to how the U.S. Federal Reserve, in an accompanying commentary to its interest decision later Wednesday, assesses both current and future economic development.
If the U.S. Fed appears more hawkish, leaning towards some form of fiscal tightening, this could send the dollar sharply higher and cause a sharp re-pricing of the dollar-denominated metals and energy sector, they said.
"The underlying supply and demand situation in the individual markets continues to play only a secondary role at the moment," said Commerzbank commodities analyst Eugen Weinber
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