Commodities Fall Out of Favor as the Dollar Strengthens

Commodities, which have been some of the most profitable investments of the past 18 months, tumbled yesterday (Thursday). Oil and gold were just a few of the raw materials whose prices plummeted on speculation that demand will slacken and the dollar will rebound in coming months.

Crude oil fell below $100 a barrel for the first time in two weeks yesterday, extending heavy losses sustained in the previous session. Oil hit a record high $111.80 a barrel Monday, but dropped nearly $5 on Wednesday.

A report from the energy department, which indicated demand for oil may be waning amid a global economic downturn, was at least partly responsible for the decline. The Energy Information Administration’s weekly inventory report said Wednesday that overall consumption of oil and its products fell 3.2% over the last four weeks compared with the same period last year.

lso, many speculative investors seem to be liquidating their assests and taking profits, as fundamentals do not support record high commodities prices.

"Commodity players seem to be coming round to the notion that the deterioration in the U.S. macro picture cannot be ignored on the pretext that commodities are a ‘weak dollar play’ or an ‘inflation hedge,’ and thus immune from downward pressure," MF Global Ltd. (MF) analyst Edward Meir, said in a research note.

The sudden epiphany that many commodities are overvalued also sent gold into a tailspin. After hitting a record high of $1,034 an ounce just four days ago, gold plummeted 12% in its biggest weekly decline in 25 years.

As is the case with oil and other commodities, investors seem to be waking up from the misconception that the price of gold will rise every time the economy, or the dollar, weakens.

Dollar Bounces Back

A resurgent greenback also weighed heavily on commodities prices. The dollar staged an impressive rally Thursday, though most analysts believe it only to be temporary. After hitting a series of record lows against the euro the dollar advanced to $1.5411 per euro.

"It looked like the sky would fall, which is why we got up to those record levels Monday," Jon Nadler, senior analyst at Kitco Bullion Dealers in Montreal, told CNN. "But when the dollar started a bit of a gain [yesterday], people pulled the trigger across the commodity board."

While the dollar came off its historic lows yesterday, few analysts believe the latest upward trend is the beginning of serious recovery. More likely is the possibility that currency traders priced in a larger cut from the U.S. Federal Reserve. The Fed slashed the benchmark Federal Funds rate by 0.75% Tuesday, but many analysts had anticipated a full-point reduction.

"The smaller-than-expected Fed Funds rate cut and the emphasis on inflation risk in the Federal Open Market Committee statement have effected a reassessment of the further outlook for U.S. monetary policy," said analysts Dresdner Kleinwort, the corporate and investment banking unit of Germany’s Dresdner Bank AG. "As the market regards the potential for another rate cut as small, gold and other metals are under pressure."

Many analysts believe after a mild recovery, the dollar will continue its downward descent, perhaps falling as low as $1.60 per euro.

"I would see this as a temporary [move] since we expect that the Fed will go on cutting. I don’t think we’ve seen the lows for the dollar and I don’t think we’ve seen the low for stock markets. It’s unlikely that this will be the bottoming out for risk aversion," Johan Javeus, FX strategist at SEB in Stockholm, told Reuters