Commodities Selloff Raises Tricky Questions

NEW YORK (TheStreet) -- Commodities-linked stocks fell sharply Tuesday for the second day in a row, led by aluminum giant Alcoa (AA), as investors continued to rotate out of commodities and, in some cases, put in short positions.

One of the triggers to the two-day declines: a note released by Goldman Sachs ( GS) Monday advising clients to close out a long commodities trade, arguing it had grown too risky.

The call focused on copper, platinum and crude oil, but some market participants appeared to view the headline as, at best, an excuse to exit the so-called "risk trade" in commodities and, at worst, a warning that the historic boom in commodities prices could be coming to an end, at least for now.

Still, said Darin Newsom, senior commodities analyst at DTN in Baltimore, nothing has served to change the underlying supply-demand dynamic that has helped lift commodities prices radically since last year. Even Goldman's analysts were sure to point out that the "structural supply-side story remains intact, and we would look for new entry points to establish new longs."

Underscoring the breadth of the selloff: the U.S. dollar weakened Tuesday against a basket of currencies. Typically, a declining greenback provides a key prop to commodities prices.

"What we're seeing today has nothing to do with fundamentals," Newson said. "It's an everyone-runs-to-the-exit-at-the-same-time sort of thing."

The analyst said he'll be paying close attention to futures spreads in some commodities categories this week, especially corn and gasoline, to see if there's any weakening in the contango. (A cantango is when futures contracts are trading at a higher price than the spot market.) If such a weakening occurs, it suggests that commercial buyers -- the actual companies that use those commodities in their businesses -- have sensed a bottom and are entering the market, an obvious bullish sign.

Trading in equities followed the action on the commodities exchanges Tuesday, where some metals, agricultural products and energy commodities were tumbling. On the Chicago Mercantile Exchange, the May copper contract was falling nearly 8 cents to $4.38 a pound. Corn for May delivery was losing 24 cents to $7.51 a bushel. And the May crude oil contract fell to about $106 on the New York Mercantile Exchange. A separate call by Goldman on Tuesday warned that ample supply and light demand will undermine oil prices, which have rocketed higher amid the political upheaval in the Middle East.

Chatter on trading desks Tuesday did center on some supply-demand fundamentals, according to market observers -- including concerns about rising copper inventories in China, the world's most voracious consumer of raw materials, whose economic chieftains have been spending the last months fighting inflation. Shares of Freeport McMoRan ( FCX), the world's largest copper producer, were declining by more than 3% to $53.59 after earlier surrendering more than 4%.

Iron ore miners were also in the red, with BHP Billiton ( BHP), Rio Tinto ( RIO) and Vale ( VALE) all lower by more than 2%. Shares of U.S. iron ore producer Cliffs Natural Resources ( CLF) were down 4.3%.

Alcoa, meanwhile, saw the worst of Tuesday's declines. The company's first-quarter report, released Monday after the bell, spooked some investors with a lighter-than-expected revenue line and, for some participants at least, a less-than-robust outlook.

Others read Alcoa's tea leaves in a completely different way, however, especially Wall Street analysts on the sell side, who saw encouraging data points in the company's first-quarter results.

Bears won the day, though, sending Alcoa's stock down 6.3% to $16.65 on nearly triple the daily average volume.

The bears were at work beyond Alcoa. "Everybody's trying to get short the commodities trade," said Lee Munson, chief investment officer at Portfolio LLC, a hedge fund.

The core argument here, he said, is the coming end of the Federal Reserve's quantitative easing program, in which it has been systematically buying U.S. treasuries with money it has printed. By removing those props, treasury yields will rise, increasing the cost of borrowing and putting a crimp on the easy flow of money that the Fed's stimulus program was designed to create. That easy flow of money, and increased money supply, has contributed to the commodities run up.

Still, Munson said, rates may not rise enough, once the Fed ends its bond buying program, to put a damper on commodities prices.

-- Written by Scott Eden in New York

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