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Hedge funds are short copper, not long; Barclays says metal stocks low

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Monday, October 2, 2006

Arrayed on one side of the commodity debate are the ivory-tower economists and perma-bears, all warning that the four-year boom is over -- with worse to come. On the other are the traders and specialists who live and breathe the stuff every day, convinced that the market is tighter across the spectrum of metals and energy than outsiders realise.

For them the commodity crash of the past four months has been a mid-course shake-out, a rare chance to jump back in for the next leg of the boom.

Paul Horsnell, commodities chief at Barclays Capital, remains defiantly optimistic. "I don't thing anything has changed. This feels like the dips we saw in 2004 and 2005, a move down before swinging to new highs," he said.

Barclays' latest report, "Pausing, not Peaking," said the worldwide stock-to-use ratio of all industrial metals was at a record low, down to five days' cover.

Far from pushing prices above their fundamental level, hedge funds have been "shorting" copper all through 2006, leaving themselves with a fearsome overhang that will have to be covered at some point by buying the metal.

China's oil demand is resuming its relentless upward push after a summer blip, with GDP growth expected to hit 10 percent in 2007, even higher than 2006. Chinese crude demand has already risen from 4.5 million barrels a day in 2001 to around 7 million this year.

Yet OPEC oil output is stagnant if not slipping, and production by the United States, Norway, Mexico, and Britain is falling fast (down 3 million barrels a day since 2002).

Mr. Horsnell said the China-led pack was now the driver of world commodity prices, making it less relevant whether the U.S. housing market turns ugly. "OECD demand for oil has been flat for two years. The growth is coming entirely from the emerging world," he said.

The International Monetary Fund has upgraded its forecast for global growth next year to a blistering 4.9 percent.

Much has been made of an International Monetary Fund report last month forecasting a metals bust by 2010. The IMF relied on an abstruse model that assumed metals will resume their gradual half-century slide as miners crank up production.

This is hard to square with a more revealing study by the U.S. National Academy of Sciences warning that mankind has already used up a large chunk of all the metals ever likely to be found.

"It is clear that scarcity value will raise the real prices of metals. Nations such as China will need to increase their average urban per capita use by seven to eight times to achieve the same level" as the West, said the report.

For good measure, let me throw in a study by the Bank of Canada predicting the migration of 300 million Chinese peasants into the towns by 2020.

But Stephen Roach, Morgan Stanley's chief economist and lead voice of the commodity bears, insists that "China mania" has intoxicated investors with fanciful theories of eternal hyper-growth.

"Commodities are as bubble-prone as any other investment," he said. "As is always the case in every bubble I have lived through, denial is deepest when asset values go to excess. That's very much the case today. I will definitely be wrong if the China slowdown doesn't materialise."

In case Mr. Roach hadn't noticed, the mini-bust has already happened, culminating last month when a Calgary trader lost $6 billion (£3.2 billion) for Amaranth Advisers betting that natural gas prices could fall no further. They fell.

Nymex gas futures for the October 2006 contract had plunged to $4.02 by the end of last week, down from a peak of almost $16 nine months ago. The Reuters CRB index of commodities is down 8 percent since May. Oil dropped 22 percent before forming a base at around $60. All now looked poised for a rebound.

I believe the sell-off was an inchoate response to the start of monetary tightening in Europe, and action by Japan to drain $300 billion of excess liquidity as a precursor to ending zero interest rates. In both cases their bark has been worse than their bite.

No surprise that Tokyo's yield-hungry grannies are once again snapping up "Urudashi" bonds in New Zealand and beyond.

In the end, I suspect the U.S. housing slump will cause some wreckage, but property slides are glacially slow -- outpaced for now by the electrification of China. Sometimes you have to put away your historical charts and simply ride the wave.

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