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Commodities continue slide as wild week ends

Hedge funds, investors further retreat from oil, metals and gold after credit woes take toll on futures markets

OTTAWA, TORONTO -- Hedge funds and other investors have pulled out of red-hot commodity markets nearly as quickly as they piled in, driven by concerns over wild volatility or the need to raise cash.

Veteran commodity players have been taking money off the table for weeks as speculators and financial investors drove up prices as they sought to hedge against a slumping U.S. dollar and stock market turmoil by betting on crude oil, gold, base metals and wheat.

But all that turned around this week, when the credit crunch extended into futures markets, where investors can buy contracts with little money down. By the end of holiday-shortened week, key commodities like oil and gold lost 10 and 8 per cent, respectively, off their peaks reached on Monday.

Markets continued their retreat yesterday as gold, silver and base metals, in particular, fell sharply. Gold dropped another 2.7 per cent yesterday after plunging 6 per cent on Wednesday; it closed at $920 (U.S.) an ounce, after topping $1,030 on Monday.

Crude oil futures also fell, slipping 70 cents a barrel to $101.84 on the New York Mercantile Exchange. Oil prices hit a low of $98.65 - the first time since March 5 they fell below $100 - after touching a record $111.80 on Monday.

Traders and fund managers working in the trenches say the flight from commodities was driven by the acute liquidity problems facing the financial community. Debt-laden speculative investors are being forced to sell off their holdings to raise cash to meet margin calls and growing collateral demands from their financers and primary brokers, who themselves are in need of cash.

The tipping point came earlier this week, when the U.S. Federal Reserve organized JPMorgan Chase & Co.'s takeover of Bear Stearns Cos. Inc. and cut rates by three-quarters of a percentage point, with the promise of more on the way.

"It's substantially forced liquidation by big speculators; that typically means hedge funds," said Richard Briggs, a veteran broker with derivatives trading house MF Global in Montreal. "They're being forced to cover."

"It's all kind of imploding," he said.

Other fund managers say they've been taking profits for weeks as speculative money flooded into the market amid growing alarm.

One investor who cashed in is Roland Austrup, chief investment officer at Integrated Managed Futures Corp., which runs a futures-market hedge fund that invests both long and short in physical commodities and financial futures like exchange rates.

"We took substantial profits over the course of the last five weeks - not so much because we don't believe in the fundamentals but because the markets had gotten far ahead of themselves," he said.

Based on the fund's risk management models, the futures markets had become too risky versus their potential returns, Mr. Austrup said. By the end of the week, his managed futures fund had liquidated its entire gold and base metals position, reduced its energy exposure by two-thirds, and moved heavily into cash.

Investors aren't ready yet to call a bottom to the commodity market selloff, though many remain bullish over the longer term, arguing that emerging market demand will underpin prices for years to come.

Oil's push above $100 (U.S.) a barrel was built on "a tremendous amount of leverage" with credit that is no longer available, said Henry Cohen, manager of Toronto-based hedge fund Full Cycle Energy.

Mr. Cohen said he has begun adding short positions in oil to his portfolio to insulate his fund from declines in the commodity prices, and he said other fund managers are starting to do the same - adding further downward pressure to oil.

"It's just starting. There's huge amounts of unwinding that has to be done here. The amount that's out there is enormous. It could take months, and it could take $20 to $30 off the price of oil."

Pat DeCicco, an analyst with Wachovia Corp.'s futures trading unit, said the longer-term fundamentals remain in place for a bull market in many commodities, notably crude oil.

"No one wants to call the bottom, and there's probably a little more to go on the downside," Mr. DeCicco said. "But every market [for individual commodities] does have an upside. We think crude oil at $100 a barrel is here to stay and gold, at $1,000, is going to be a new reality."

© 2007 The Globe and Mail. All rights reserved.

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