Funds Fuel Commodities Price Boom; Miners Benefit

Fund and speculator buying drove copper and gold prices on the London Metal Exchange through key psychological levels Tuesday, taking mining stocks up too, and there's more on the way say sector specialists.
Supply jitters in the copper market that's seen Grupo Mexico SA (GMEXICO.MX) declare force majeure at its La Caridad mine due to a strike pushed LME benchmark copper for three-month delivery to $6,005/ton early Tuesday, up 26% since January while gold rallied to $604.25/oz, up about 17% since the start of 2005. Silver raced to a 23-year high of $13.03/oz although profit taking pared some of the gains late afternoon.

"There is a wall of investment money moving into commodities markets," said UBS analyst John Reade. "We estimate around $100 billion was invested via the Goldman Sachs index, the Dow Jones/AIG index and products tracking those indices at the end of 2005," but not including fund investors trading commodities via other financial products.

Traders said institutional investment through long-only indices will help maintain prices above fundamentals.

"Pension funds just want exposure," a senior trader said. "They take a long-term view on the market and largely ignore the day-to-day price moves. Copper is just one of the components of their commodity investment."

Stringent rules on pension fund investments mean lag times of up to two years between a fund's initial interest in a market and trustees giving the go-ahead to invest.

As a result they often add positions at a time when markets are overbought, analysts said, extending the bull run beyond fundamentals. It also allows other funds and speculators with a riskier trading approach toforce out short position-holders to push prices even higher, they added

Pension funds such as the U.K.'s Hermes Pensions Management, Dutch pension fund PGGM Investments and J Sainsbury PLC (SBRY.LN) have announced a move into commodities for diversification purposes, with a typical 4%-6% allocation.

This institutional interest means the copper price is running counter to previous forecasts for 2006 and some traders and commentators say the market has the hallmarks of a bubble.

At the beginning of the year, the industry consensus forecast was for copper prices to ease during the year as supply caught up with demand.

But metals analyst Jon Bergtheil at JP Morgan said despite most analysts predicting a 200,000-300,000-ton copper surplus for 2006 and 2007, the copper price surged, pointing to a bubble in the market.

Bergtheil said despite the prospect of rising inventories, few market participants are willing to say fundamentals will reassert themselves as the key driver of near-term prices, with fund flows maintaining the upper hand.

A trader told Dow Jones Newswires: "Any small bullish story appears to be enough for the bulls to seize upon."

On the demand side, some analysts said base metals will continue to draw strength from industrial production growth in China.

"In 2006, it is likely that the Chinese economy will slow down to a GDP growth rate of 9.5% on year from around 9.9% in 2005, which by all means is still a very reasonable increase in activity," Macquarie said in a recent research note. "High economic growth will be reflected in industrial production. The positive outlook for the Chinese economy means that we should also see another year of growth in the construction sector."

The factors behind gold breaching the key psychological level of $600/oz are similar to base metals, analysts said, but the fact that it is seen as a natural currency hedge and safe-haven investment amid geopolitical tension will add further allure.

Tension between the U.S. and Iran over Iran's nuclear ambitions, continued violence in Iraq and concerns for the dollar due to the U.S. twin deficits will keep gold in good shape, they added.

The commodities boom is driving gains across the mining sector. Since the start of the year Chilean copper miner Antofagasta PLC's (ANTO.LN) shares have risen 24%, trading at 2370 pence at 1158 GMT Tuesday. Kazakh mining company Kazakhmys PLC's (KAZ.LN) shares gained about 53% over the same period.

A stronger outlook for commodity prices led Deutsche Bank mining analyst John Mackinnon to upgrade Anglo-Swiss miner Xstrata PLC (XTA.LN) and diversified natural resources company Anglo American PLC (AAUK) to buy from hold.

Mackinnon also recommended diversified miner Rio Tinto PLC (RTP), the world's biggest mining company by market capitalization BHP Billiton PLC (BHP) and Indian metals and mining company Vedanta Resources PLC (VED.LN).

"Stronger commodity prices and surging earnings and cash flow remain key catalysts to further sector outperformance in 2006," Mackinnon said in a report.

In late trading Tuesday, LME copper was up $58/ton on the previous PM kerb at $5,968/ton, zinc was up $51.50/ton at $2,962.50/ton, gold was up $0.25/oz on the London PM fix at $598/oz, and silver was at $12.72, up on the London PM fix of $12.67/oz.