Commodities could benefit from market turmoil

As the eurozone weaves its disastrous spell across the markets, commodities have suffered more twists and turns than a rollercoaster.

After soaring to two and a half year highs earlier in the year, oil prices took a steep tumble amid fears for a demand slowdown, while gold slumped from its record high as investors fled the commodities market and copper has shed 8% this month alone.

Economists at Capital Economics expect the escalation of the crisis in the eurozone to contribute to further large falls across almost all commodity prices over the next year or so, bar gold and silver.

US banking giant Goldman Sachs echoed the sentiment when it raised its outlook for gold while downgrading its overall outlook on the commodities sector.

For more on the pros and cons of investing in commodities, read: Precious metals: To have or to hold?

There's little surprise in that given that Europe is precariously facing a second recession, with those outside of Europe's borders also at the mercy of the high debt levels and lack of growth.

But while a further downturn is expected, there are certain factors to arise from the unfolding crisis which should prevent the sector suffering a freefall.

Central bank response

Global central banks will be forced to respond to the dramatic worsening of the crisis and this almost certainly includes additional quantitative easing. And where vast sums of liquidity enter the financial system, some will undoubtedly find its way into the commodity sector.

However, while the loosening in monetary policy in 2008 and 2009 failed to prevent commodity prices from collapsing, the scope is somewhat limited with interest rates already close to zero across all the major economies.

Rest of the world

The dire situation in the eurozone is being felt across the world, with various other economies exposed to events.

In a bid to cushion their economies, there is the possibility that they will boost investment spending, which could see commodities benefit.

"The quickest way for the Chinese authorities to stimulate demand is a relaxation of controls on bank lending, which could also lead to a temporary surge in commodity-intensive spending," said Capital Economics chief global economist Julian Jessop.

High inflation

Governments battling high levels of debt, be it public or private, may view a burst of inflation as a lesser of the two evils. With costs spreading across society to ensure solvency of banks, it would also support the prices of "real assets", with commodities rating amongst those.

However, Jessop warns that while authorities might tolerate slightly higher rates of inflation, it is by no means an easy way out.

"There is the risk that inflation gets out of control, harming efficiency and economic growth and eventually requiring another recession to bring it back down again. In practice, it is also hard to see how the authorities could engineer much higher inflation anyway."

Farewell euro

There has been much debate as to whether the debt crisis currently spreading across Europe will force a break-up of the euro.

If this were to happen - and it remains an unlikely if - one uncertainty hanging over the global economy would have been lifted and there would be a race for governments to adopt policies to boost demand in their economies.

If weaker parties were to leave the single currency, it could well prompt an appreciation in value, thus undermining the safe-haven quality of the dollar, whose strength can often result in lower commodity prices.

That said, this would only be the case once the dust has settled and there would be much chaos to manoeuvre first.

Jessop added: "The policy responses that might help support commodity prices cannot be expected to offset the full impact of the economic and financial problems that required these responses in the first place."

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