Oil is not the only commodity on a tear

AS OIL prices touched $89 a barrel this week, the temptation was to seek an explanation in geopolitics. Many cited a potential incursion by Turkish soldiers into northern Iraq. Some believed gold's rise to a 27-year high was driven by the same factor.

Fuelling the supercycle

But the commodities market is being affected by a lot more than just events in the Middle East. Prices of raw materials are seeing widespread gains as talk of a “supercycle” is in the air. Copper, lead, soyabeans, wheat, cotton, coffee, cocoa and feeder cattle have all registered double-digit percentage gains this year.

Some of these gains can be traced back to the rise in oil prices. The planned substitution of ethanol for petrol encouraged corn planting, which took acreage away from crops like soyabeans and led to a surge in prices. Higher livestock prices can, in turn, be explained by higher grain costs.

But the broad strength of commodity prices may also reflect the appeal of the sector as an “alternative asset”, along with hedge funds and private equity. Ever since the dotcom bubble burst, investors have been keen to diversify away from shares and government bonds. That has led to the launch of a whole series of exchange-traded funds based on commodities, which have made the asset class accessible for a much wider range of investors. The latest example, from Barclays Global Investors, a big asset manager, is a fund based on timber prices. Wall Street has been gearing up to meet demand: a survey by Options Group, a recruitment consultant, found that the hiring rate of commodity traders is up by 33% on last year.

The recent credit crunch may have given commodities a further lift. Speculative money that had been flowing into high-yield bonds and structured credit is now looking for a new home. Some commodities, particularly gold, are also seen as a hedge against a declining dollar.

Robin Bhar, a metals strategist at UBS, says investors seem to feel they have an each-way bet on commodity prices. Either global economic growth is strong and supply remains tight, or the world slips into stagflation, as it did in the 1970s. Commodities should perform well either way.

Such a bet could still lose money, of course, if the world slipped into a non-inflationary recession. But investors seem to feel that the global economy can overcome the problems in the American housing market. Peter Oppenheimer, a strategist at Goldman Sachs, says that high metals prices reflect the strength of the BRIC economies (Brazil, Russia, India and China), which contribute twice as much as America to global consumption growth.

Individual commodity prices are still highly volatile thanks to speculative demand. A sharp rise tends to attract “momentum” investors, who push prices up even further until end users start looking for alternatives. At that point, the momentum buyers retreat. But oil's attractions to investors have increased recently because the market has moved into “backwardation”, where futures prices are lower than the current price. Investors can thus earn a “roll yield” by buying the future and waiting for the price to rise to the spot level.

The key factor, however, is the tightness of supply. Francisco Blanch of Merrill Lynch reckons that supply contracted by 500,000 barrels a day in the third quarter while leading economic nations entered the fourth quarter with their lowest stocks for four years. Mr Blanch reckons it would not take much to push the price to $100 a barrel. If it gets there, stockmarkets may face an interesting test of confidence.