Bahana: Lower commodity prices: Trial and blessing to balance woe

Harry Su , Senior Vice President, Head of Research | Wed, 09/03/2008 10:43 AM | Business

Many overseas and local fund managers are still trapped in commodity-related stocks, in particular coal and CPO plays.

This is because the correction in commodity prices back in July, which coincided with the release of China's slowing 2Q08 GDP growth, was so fast and steep that it prevented most market participants from exiting in time.

We recently learned that domestic pension funds are also trapped in commodity counters. What's worse is that these local pension funds, by law, are not able to sell at a loss.

This means that these institutions will simply have to keep all these commodity stocks on their books until such time that the respective share prices return to at least their original purchased prices.

That said, any bounce in future oil or commodity prices would be used by both overseas and local fund managers to trim their positions and rebalance their portfolios into other non-commodity plays such as banks, telcoms and consumer, which will benefit from lower inflation stemming from the decline in commodity prices.

Going forward, continued selling pressure will make any upward move in commodity stocks short-lived in our view.

This will lead to one thing: a decoupling between the fundamentals and share price performance of commodity stocks like coal and CPO.

Irrespective of the supply and demand situation, commodity stocks are likely to underperform in the short to medium term until the above-mentioned selling pressure dissipates.

Additionally, sentiment on commodity counters like coal and CPO will also hinge on oil price performance.

So where are oil prices headed? Back in May/ June this year, many investors were still looking at oil prices breaking the US$200 per barrel level.

However, since sky-rocketing oil prices were driven by speculation, we began to witness demand dissipation as oil closed in on the US$150 per barrel level.

Earlier in the year, many investors believed that Asia, propelled by fast-growing China and India, could decouple from the economic slowdown in the United States.

Now it is clear that no one could decouple, even with the European Union still going through a denial phase, keeping their interest rates high at 4.75 percent.

With the United States and Europe accounting for about 40 percent of Chinese exports, the consensus view now is that China will not emerge unscathed.

And this will undoubtedly lead to a ripple effect across Asia, negating the decoupling theory of Asia from the Western economies.

Hence, it is not surprising that investors today are talking about oil prices heading back down to $70 per barrel.

Whatever level oil prices will eventually settle down at, it is clear that we have seen the peak in oil prices and that the current trend is certainly down, particularly when the European Union cuts its interest rates in the later part of the year, leading to a further strengthening in the U.S. dollar, which will exacerbate the decline in commodity prices.

Against such a backdrop, the Indonesian stock market's performance will be less than stellar since commodity-related components account for 35 percent of the Jakarta Composite Index.

However, this trial brings a blessing in the lead up to the 2009 elections for the current Susilo Bambang Yudhoyono administration, as lower oil prices paving the way for an improved budget deficit as well as lower inflation and lower interest rates ahead, conducive to jump-starting the economy through infrastructure-related projects.

The analyst can be contacted at harry.su@bahana.co.id

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