By Nicolas Robin, Commodities Fund Manager, Threadneedle

The past week has seen weakness in commodity markets, mainly triggered by the long liquidation that took place in Silver over the last 10 days. It appears some market participants believe this is a replay of the sharp sell-off seen in commodity markets in the second half of 2008. However we think those concerns are overdone and that this correction presents a significant opportunity for adding length into commodity markets.

The current situation is very different to that of late 2008, where the backdrop was the credit crisis. At that time it was the lack of credit which disrupted commodity trade flows, leading to the sharp sell-off. The first part of the crisis (towards the end of 2007) had seen commodity prices continue to rally and base metals were the first market to turn. This was exacerbated by some large exotic trades which proved extremely toxic for some players. We do not see the same trades in the current market. At the same time, the rally in energy prices since the start of the year has been motivated by fundamentals.

We currently remain overweight energy for four main reasons:

1. The rally in crude prices took place on the back of real supply disruptions coming from Libya. We think those disruptions will endure. Indeed, no outcome to the current conflict sees a resumption of previous conditions - should the Gaddafi regime remain in power it will be affected by embargos (on both crude and on key supplies required to maintain fields). Alternatively, success for the rebels will see further damage to oil infrastructure and continued political instability.

2. Leaders in the Middle-East increased social spending to gain popular support as the wave of revolution developed in the first few months of the year. This was particularly true in Saudi Arabia where, according to some estimates, crude values in the mid US$80s are needed to balance the budget. This has arguably pushed up the floor for crude prices, while political risk remains.

3. The earthquake in Japan and its impact on the nuclear industry places long-term upward pressure on demand. As the country struggles with nuclear outages, we anticipate Japanese demand for oil product to be up significantly.

4. The US gasoline market continues to be very strong, and cash gasoline markets in the US North East have continued to strengthen against futures despite the sell-off. This is on the back of supply disruptions including refinery outages, pipeline problems moving gasoline from the US Gulf Coast, lower than usual European exports to the US and, more recently, floods disrupting barge traffic from the US Gulf Coast, and will provide some underlying support to crude oil markets.

Silver has been the only commodity market to show signs of over-extension since the start of the year. We believe that the technical picture for Silver was very strong and this helped fuel the over-extension. Threadneedle was able to capture a good deal of the move by running an overweight position in the Silver market (vs underweight Gold) that we gradually reduced during the course of April and finished closing out early last week. It's worth noting that the Silver market remains a small weight in the main benchmark indices and that the liquidation experienced cannot, and should not, be extrapolated to other markets.

Threadneedle's current positioning

We currently hold a small overweight in Energy with our conviction trades being overweight US Gasoline and Heating Oil and underweight US Natural Gas. We are slightly underweight Grains and Softs owning to the large speculative length and negative seasonality that we see in those markets. Within metals, we have reduced our overweight in Copper to market weight, and are currently overweight Nickel versus underweights in Aluminium and Zinc. Finally, in Livestock, we carry our market weight in Feeder Cattle as opposed to Lean Hogs and Live Cattle where we saw the speculative length as being excessive.

We take into account liquidity flows when managing our exposure and have been very pro-active in reducing exposure to those markets where we felt that speculative length was running too high. This is why we reduced our overweight in the Silver market over the last month and are now market neutral. We've been taking similar steps in Cotton and Sugar where we ran small underweights and pushed our positions to the back of the curve. We've recently reduced our Copper exposure to market neutral for the same reason.