Renate van Ginderen writes: Generally, investors remain very bullish on commodity markets. No surprise there - the Fed is still inclined to pursue an extraordinary loose monetary policy. Should macro-economic data deteriorate in 2011, however, this could still be interpreted as positive to asset prices as in that case the Fed will be more likely to opt for a new round of quantitative easing. Therefore, one can expect upward pressure on commodity prices over the coming weeks to months, albeit probably with an intermediate correction, as explained below.

Supply-demand imbalances?

Bernanke claims that the prices of energy (and many other commodities) have risen in recent months on the back of a mismatch between demand and supply. Arguably, high growth in - especially - the emerging markets was driving up demand whereas bad weather conditions and political turmoil in the Arab world undercut supply. On this basis, Bernanke and a number of other important Fed governors view inflation as a temporary phenomenon. As yet, they see no reason to tighten monetary policy, thereby causing investors to remain extremely bullish on commodity markets.

Fed still dovish

At the same time, a very large group of economists and investors believes that the Fed’s policy (which has led to the creation of huge amounts of extra liquidity) contributes greatly to the commodity price rally.

Also after last week’s Fed meeting, there was no need for investors to stop speculating on rising resource prices; the central bank indicated that it would continue its program of quantitative easing (QE II) until the end of June. Subsequently it plans to monitor developments closely. There were veiled hints that the US central bank would be prepared to print new dollars should asset prices start to plummet once again, in order to underpin the asset markets and prevent deflation.

All of this could take the markets back in time to August - October 2010, when dismal macro-economic data gave plenty of reasons to be cheerful, because slowing growth was expected to (and did) lead the Fed to ease its monetary policy. Once cannot rule out that such a scenario will unfold again.

Intermediate correction?

US fiscal stimulus has been largely applied in the first quarter of this year. Yet, as budget deficits are huge, the administration will be under mounting pressure to apply ever more fiscal tightening. However, the US economy has not sufficiently recovered to grow at an acceptable rate (around 3%-3.5%) if it lacks a loose fiscal policy, given that unemployment is still high, real incomes are stagnant, consumers are unwilling and unable to increase spending significantly, and property prices are close to their 2009 lows. In other words, growth is simply too sluggish.

Additionally, attempts by the authorities in emerging economies to put the brakes on growth (in order to counter inflation) have not had any visible effects. In 2011, real growth in China is expected to be 9%-10%. One should take into account, however, that later this year intensive tightening in the emerging economies could still dampen growth in these countries.

At the same time, high oil prices could undermine growth expectations in the US and elsewhere. This is bad news for asset prices. Under such conditions many US carry trades will unwind as the US dollar appreciates. The intermediate result will be a correction in commodity prices.

Bad news = good news?

Hence, it is not unlikely that US economic growth will further loose momentum in the course of 2011. If so, worsening economic data could well go hand in hand with an upbeat mood of bad news = good news, given that bad news will imbue investors with hope that the Fed will once again wave the magic wand of quantitative easing, although possibly only after a sizable correction. Subsequent renewed speculation could well drive up resource prices.

Nevertheless, the long-term trend will remain upward. Especially as resources are likely to become ever scarcer whereas the emerging industrial countries have a lot of unexplored growth potential. Add to this constant geopolitical tension and a Fed policy that tends to be expansionary rather than restrictive, and there may well continue to be more liquidity in the system than the real economy can absorb. This provides a recipe for upward pressure on commodity prices in the long term.

Bio: Renate has joined the analyst department of ECR Research in July 2010 as a financial market analyst. With a bachelor's degree in International Business, and International Economics and Finance, a masters degree in the latter (from Tilburg University), and several courses in econometrics, she looks at the financial markets mainly from a macro-economic perspective. She is specialized in, and co-author of the ECR Research publications about Japan, Canada, Australia en the commodity markets. Moreover, she studies economic developments in China and analyzes their impact on world markets.

Renate van Ginderen
Analyst Financial Markets

ECR Research (www.ecrresearch.com) is one of Europe’s leading independent macroeconomic research institutes focusing on the main currency and interest rate markets. The ECR reports reach a worldwide audience of sophisticated investors and treasurers and CFO’s within corporations and financial institutions. ECR offers a wide range of research products which are online accessible and updated on a weekly basis.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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