Liquidation Event Could Push Commodities Down 25%, Barclays Warns

Barclays has warned that commodities are vulnerable to a wave of investor liquidation event that could push the prices down as much as 25 percent.

"Investors have been attracted to commodities as one of the best performing assets so far in 2016. However, in the absence of any concerted fundamental improvements, those returns are unlikely to be repeated in Q2, making commodities vulnerable to a wave of investor liquidation that we estimate could, in a worst case scenario, knock as much as 20-25% from current price levels," analyst Kevin Norrish wrote in a note.

Norrish noted that "given that recent price appreciation does not seem to be very well founded in improving fundamentals and that upward trends may prove difficult to sustain, the risk is growing that any setback will result in a rush for the exits that could again lead commodity prices to overshoot to the downside."

According to the report, key commodities markets such as oil and copper already face overhangs of excess production capacity and inventories, but also now face another obstacle in the recovery process, that of positioning which is now approaching bullish extremes.

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Barclays said net flows into commodity investor products totaled over $20 billion in January-February (the strongest start to a year since 2011), futures positioning in key markets such as copper. In addition, the report said oil has switched rapidly from bearish to bullish extremes in a few short weeks and there is evidence of a surge in investment flows into Chinese commodity markets as well.

"The risk for commodities is that investors seek to liquidate long positions quickly and in unison, with potentially highly negative consequences for prices. There are several reasons to believe that a short-term turning point for investor flows might be close," Norrish noted.

The analyst said the current commodity investment is "more short term and opportunistic," a trend visible from the relatively short holding period for ETP buyers in oil. Norrish said many have been liquidating on the recent move up in prices, having held their positions for only 5-6 weeks.

"Commodities are among the few assets that have generated a positive return in Q1 and, as quarter-end approaches, that may make investors keener than they would usually be to close out long positions and lock in profits."