24/11/2008 (The Economic Times) - It is said that food is recession-proof. However, if the recent weakness in vegetable oil prices is considered, the above statement may not seem to be as true as it sounds. For an investor in the vegetable oil market currently, the clock has turned three years back to ’05, when the early signs of a boom in the commodities market were just beginning to show. The rally, which took three years to build, fizzled out in barely three months.

International trade in the vegetable oil market is primarily dominated by palm oil traded on Malaysian Derivatives Exchange (MDEX) and soyabean oil traded on Chicago Board of Trade. Like with most commodities, prices of these oils had also started climbing in wake of the general commodity bull run.

Certain agricultural commodities like corn, soyabean oil and palm oil have established a new-found association with crude oil prices due to their use in bio-fuels, which emerged as an alternative to crude oil. These commodities, therefore, started gaining favour among investors as crude oil prices started climbing up. Hedge funds also begun to increase their long positions in these commodities. Consequently, they started sharing a high correlation with crude oil prices. For instance, palm oil and soya oil share a correlation of 83% and 92%, respectively with crude oil prices since the beginning of ’05 till date.

Physical factors like the floods in Malaysia and Indonesia (the major producers of palm oil) and dry weather in the US (the major producer of soyabean) further fuelled the bullish sentiment in commodities.

Till the time crude oil prices were rallying, the going was good for most edible oils and oilseeds. However, with the turn of events in the larger scheme of things, the scenario for the commodity market also underwent a change. Crude oil prices have crashed by more than 65% since their peak in July this year, and while falling, they have taken the edible oil basket along. Palm oil prices have fallen by nearly 60%, while 54% of the gains made earlier by soyabean oil have evaporated into thin air.

Investment demand seems to have vanished from the vegetable oil market in line with a similar trend in crude oil prices. All these negative developments have also impacted demand and supply dynamics in the physical market. The bulk buyers, who book their stocks well in advance in bull markets , have chosen to follow a hand-to-mouth buying pattern in a falling market, leaving commodity producers with excess supplies.

So, where do edible prices oils go from here? The current financial crisis has strained most assets of surplus funds which, till recently , were propping up commodity prices. Besides, crude oil prices have been falling steadily day after day, aggravating the uncertainty in the edible oil market. However, support has been lately holding out at lower price levels in case of edible oil prices. This is because there is a significant food demand, over and above the demand for biofuel. Palm oil is also used in soaps and detergents. These non-crude oil related demands are expected to sooner or later support prices.

While the days of strong long-drawn rallies may be gone for a long time to come, it may not be a great idea for investors to go aggressively short on the edible oil basket at the current price levels. A likelihood of weakening correlation between crude and edible oil prices also cannot be ruled out.