Three-Ring Circus

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In the interim, intrepid reporter Polya Lesova over at Marketwatch set out to poll a number of analysts for their opinion on this, the hot topic of the month - perhaps to be the topic of the year as well. Here is what she found:

"Powerful performance in commodities over the last couple of years raises the plausibility that aggressive assumptions have further driven up prices that appear to be on the verge of correcting meaningfully as deleveraging in various asset classes continues to play out," wrote Tobias Levkovich, chief U.S. equity strategist at Citigroup, in a research note dated March 20 and released to the media on Monday [today].

Deleveraging refers to the unwinding of trades funded by borrowed money. In his note titled "The case for crumbling commodities," Levkovich argued that all credible investment theses have factual basis that tend to get overdone.

"The impressive economic development of Brazil, Russia, India and China has spawned a sense of never-ending growth that has stoked speculative juices," Levkovich said. However, he warned that "a number of catalysts may be coming together to end the current commodities craze."

A few excerpts from the Levkovich/Citi report are worth some further thought as they may prove valuable in coming months:

1. "While economic conditions in Europe already were getting tenuous, the sharp move in the Euro of late could further pressure this export oriented region, with Japan facing similar problems given the rapid appreciation of the yen. In this context, 70% of global GDP could be in recession or heading towards much more challenging times. As Citi economist Steven Wieting points out, European real consumer spending fell sequentially in 4Q07, which has not even happened yet in the U.S. Nonetheless, many investors worry about the American consumer being "spent out" with no savings and falling home prices."

2. " As U.S. industrial trends worsen by mid-year and into 2H08, we would expect the demand for commodities to slide further alongside a likely meaningful fall in commercial construction activity. Furthermore, we could see the ECB trim rates in mid 2008 to help address global credit markets especially if inflation pressures ease as a result of weakening economies. Note that the potential for currency market intervention is growing because the rapid descent of the dollar in 1Q08 has governments and central bankers worried about local economic impact. If they worry and feel a need to step in, speculators do not want to take the risk that central banks might crush their positions. A coordinated effort such as those experienced in the 1985 and 1987 periods (with the Plaza and Louvre accords) is not something to trifle with, and hedge funds could pull back and get out of harms way, especially in a de-leveraging world."

3. "In summary, the investment theses surrounding commodities looks poised to be tested very meaningfully (as we have pointed out for weeks) and we would prefer to avoid many of the affected stock areas. To be fair, while we get pushback from clients who are overweight the various industry groups we consider to be at risk, we have noted a slight change in attitude over the past few weeks. We think that the January volatility caught many investors (both hedge funds and traditional long-only oriented funds) by surprise and hurt their performance. Thus, a new sense of wariness may be developing and could gather steam. Caveat emptor!"