Commodities Rally Is Likely To Continue Rest of Week - CNBC

Asset rebalancing by commodity indexes and mounting signs of a well-rooted economic recovery are expected to keep a tide of money flowing into commodities this week, pushing prices to new highs.

Copper started the new year with a record high and oil scaled a two-year peak after U.S. factory and housing data on Monday pointed to better recovery in the No. 1 economy, alleviating concerns investors had lately about growth in Chinaand Europe.

The real test of the December rally in many commodities will come on Tuesday, when traders and investors in Japan, China and the UK return to work for what is likely to be the first fully active trading session in two weeks.

The Reuters Jefferies CRB index rose more than 10 percent in December, its best monthly gains since May 2009, when markets were recovering from the previous year's collapse.

While the global recovery is expected to be the main driver for investments this year, this week's focus will partly be on the short-term issue of rebalancing major commodity indexes such as the Dow Jones-UBS and the SPGSCI.

The indexes, which command an estimated $200 billion of passive investment, typically adjust their weightings in the first two weeks of January, based on their formula for dividing allocations between futures markets.

Investment bank JPMorgan Chase [JPM 43.58 1.16 (+2.73%) ] has said it expects natural gas and crude oil to see the largest weightings increase from the rebalancing, scheduled between the fifth and ninth business days of this month, or January 7 to the 14th.

Although the rebalancing is expected to result in a net outflow of about $3.8 billion from commodity markets, according to calculations by Reuters, analyst expect little negative impact on prices.

"People are generally upbeat over the index reweighings. Also, there'll be new money coming into commodity hedge funds at the start of the year, so there's no real worry about inflows at the moment," said Shawn Hackett, commodities analyst at Hackett Financial Advisors in Boynton Beach, Florida.

"The question on whether the prices we're seeing now are sustainable will only come later, when some of the noise in the market dies down and there are fewer cross-current financial shifts to distort prices."

JPMorgan valued investments in the SPGSCI at $120 billion and the DJUBS at $76 billion, without citing the financial impact from the reweighings.

It said natural gas, last year's worst-performing major commodity with 21 percent loss, will gain a 4.6 percent increase from the rebalancing on the SPGSCI and DJUB.

The U.S. natural gas front-month contract for February [NGCV1 Unavailable () ] jumped 5 percent to nearly $5 per million British thermal units in Monday's early trade, bolstered partly by investments expected to come into the market as the new year begins.

A return of weekday industrial demand after the holidays and continued cold weather in the U.S. Northeast region were other factors supporting gas prices, traders said.

"Natural gas prices are near the low side of the last 20 years and look to be in an ideal location for a major upside spike in price in 2011," Hackett, the analyst, said.

JPMorgan estimated a boost of just over 1 percent in weightings for crude oil from the rebalancing.

U.S. crude oil gained 15 percent last year and is expected to extend its current two-year high of above $92 per barrel toward the key $100 level.

Using prices of the contract months to be bought and sold under the rebalancing as cited by JPMorgan, Reuters calculated a potential net inflow of $1.2 billion for the energy sector and net outflows of $995 million for metals and $4.0 billion for agriculture.

Aside from index rebalancing, the economic calendar in the first week of the new year will be dominated by global manufacturing sentiment indicators, U.S. new vehicle sales and nonfarm payrolls data, which are expected to show unemployment easing to 9.7 percent in final month of 2010.

In addition, Federal Reserve Chairman Ben Bernanke goes before Congress on Jan. 7 to testify on the economic outlook, his first public remarks since President Barack Obama and Republican lawmakers struck a tax deal that is expected to lift growth next year by up to 1 percentage point.