Why commodities could weather market volatility

Investors should be warned not to overreact to movements in commodities markets, as the fundamentals paint a picture of constraints on supplies and surprisingly strong demand, writes Investec fund manager George Cheveley.

With eurozone crisis concerns dominating and economic indicators showing world growth will slow over the coming months, commentators have become increasingly bearish on the outlook for commodity demand.

As a result, prices for many commodities have fallen sharply. This is a logical response to the challenges faced by industries around the world as many companies review their capital expenditure and working capital levels, postponing developments and destocking where possible.

Although many companies have December accounting year-ends and this makes a lot of sense in the current environment, there is a danger that the market overreacts to these signals, particularly in individual commodities.

Commodity prices are determined by many constantly changing factors but the fundamental balance of supply and demand is critical in deciding if prices should be higher or lower.

Thus, while the outlook for demand may be weakening, if the supply picture is already weak or deteriorating then prices may not fall as far or for as long as might initially be expected.

This could certainly be the case for some commodities currently, for example, copper.

Positive signs

The world looks as though it is now on a slower but steady recovery, and it has looked so for some time. Global GDP has been growing rather than experiencing a downturn into severe recession.

In the US the key drivers of growth, including retail spending and the housing market, came in stronger than expected and leading indicators remain marginally positive.

Key Chinese growth drivers, which lean to industrial production, paint a similar picture.