Analysis - China the wild card for commodity prices

LONDON Tue Feb 15, 2011 1:26pm GMT

LONDON (Reuters) - A strengthening global economy and growth in demand are likely to keep commodity prices high in coming months, but there is a risk China could slam on the monetary brakes and trigger a reversal.

Low inventories make copper and corn favourite bets for investors this year as long as prices stay strong.

"Commodities are benefiting from the global recovery. The emerging world is still growing very strongly, and its demand for metals is still very strong," said Robert Talbut, chief investment officer at Royal London Asset Management.

Copper prices have surged on signs of strong manufacturing growth in the United States, the world's largest economy, and in China, which has accounted for a high proportion of growth in demand for commodities in recent years.

The metal, used widely in the power and construction industries, shot through the key $10,000 a tonne barrier earlier this month and on Tuesday hit a record high of $10,190 a tonne after below-consensus Chinese inflation data.

Corn prices have vaulted to 2-1/2 year highs above $7 a bushel, and Brent crude oil at above $100 a barrel is near its highest levels since September 2008.

"What we have clearly seen since the end of last year is economic improvement, specifically in developed economies," said Koen Straetmans, senior strategist at ING Investment Management.

"I am overweight industrial metals such as copper. I don't expect energy to outperform base metals or agriculture."

CHINA THE WILD CARD

Some fund managers say they expect China to sap sentiment as the world's second-largest economy combats stubbornly high inflationary pressures with higher interest rates.

But others say that price declines such as those seen after China raised interest rates on February 8 are buying opportunities.

"We don't think there is going to be significant global monetary tightening this year," Talbut said.

Accelerating food price inflation has been driven by surging prices for commodities such as U.S. wheat near 2-1/2 year highs, Arabica coffee reaching a 13-1/2 year peak and raw sugar its highest levels in more than three decades.

It is a mounting worry for world leaders and has contributed to political unrest in countries with high poverty rates, as evidenced in the toppling of Tunisia's president in January. That unrest has spilt into Egypt, Yemen and Jordan.

Many investors are overweight equities and commodities -- exposure to growth.

"We've come up so fast, so steeply and so many people are in this game, that the minute it breaks, we'll see liquidation of the longs, said Sean Corrigan, chief investment strategist at Diapason Commodities Management.

"It's not one to ride with your eyes shut."

INVENTORIES KEY

Inventories are the key factor that differentiates the prospects for commodities.

"Price risks are likely to be skewed to the upside for markets where we have low inventories ... In this regard we would highlight copper," said Stefan Graber, commodities analyst at Credit Suisse Private Banking.

Copper stocks in London Metal Exchange warehouses are up about 50,000 tonnes since December to above 400,000 tonnes, a fraction of the estimates for total consumption at around 21 million tonnes this year, compared with 19 million in 2010.

Current stocks compare with levels near 555,075 tonnes in February 2010 and more than 980,000 tonnes in May 2002.

"With limited supplies coming on stream over the course of this year, price gains for copper are going to be with us for the time being," Graber said.

"For oil there is spare production capacity," he added.

OPEC spare capacity is pegged at about 5 million barrels per day, which can be turned on quickly in case of shortages.

"Oil has benefited from global recovery, but it has also more recently gained from concerns about potential supply disruptions in and around the Gulf," Talbut said.

"It is possible oil will retrace, but we are not contemplating plummeting prices," he said.

For corn the story is one of persistent supply shortfalls, mainly because of increasing affluence and meat consumption in developing nations as well as rising ethanol production.

The latest U.S. estimates were for corn stocks to fall 9 percent this year to 15-year lows as a record amount is used to make the biofuel ethanol.

"Tightness is likely to persist," Graber said.

(Additional reporting by Barbara Lewis, Nigel Hunt, Eric Onstad and Nick Trevethan; editing by Jane Baird)