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. Last Updated: 07/27/2016

Drop Copper, Try Paper: Analysts

LONDON -- Investors fleeing the heat of commodity markets should consider putting their money into two-year U.S. paper, some analysts are advising.

As heavy copper losses at Japan's Sumitomo Corp. inflicted further pain on battered commodity markets, analysts said investors could reap rewards in the U.S. short-end, where interest rate concerns have been heavily overplayed.

"The U.S. market has got itself into such a state of gloom that it is overdiscounting the worst the Federal Reserve may do this year," said Stephen Lewis, at London Bond Broking Co.

"It's so far out of line ... looking at inflation-adjusted short-dated yields, compared with those elsewhere, that for international investors it's going to have attractions," said Lewis, research director at London Bond Broking.

Copper plunged to a two-year low overnight after Sumitomo said earlier this month had lost $1.8 billion in unauthorized copper trades over the past 10 years.

It bounced back up in London after the London Metal Exchange said the market was robust enough for a satisfactory resolution of the Sumitomo crisis, but it has remained twitchy.

Copper and other commodity markets like grain and precious metals have already toppled off dramatic spring highs as supply and demand came into better balance.

Analysts said the recent volatility would have little effect on international bond markets but may accentuate a flight already under way to the short-end of the U.S. yield curve.

"It's helped sustain what are quite clearly moves into shorter-dated bonds," said Stephen Hannah, head of research at IBJ International in London.

"If you want to immunize yourself against any unpleasantness up the curve, you're much better off being in two-year paper than five- or 10-year paper," he said.

He said the two-year area still looked cheap even if the Federal Reserve increased interest rates at its next Open Market Committee meeting on July 2 and 3.

With two-year notes currently trading with a yield of 6.34 percent, the market is discounting more than a 1 percentage point rise in the federal funds rate, currently at 5.25 percent.

London Bond Broking's Lewis agreed that investors could still squeeze some life out of the two-year area.

"Once momentum of flows gets going into the short-dated end of the U.S., then I think that part of the market is going to be buoyed up by international demand," said Lewis.

And he preferred the short-end of the U.S. over the other dollar bloc countries -- Australia and Canada.

The course of Australian monetary policy was uncomfortably muddy for Lewis. "With Australia you've also got a currency risk and the fall in commodity prices magnifies that risk," he said.

He said he would prefer to buy longer-dated Canadian debt which would continue to profit from subdued economic conditions.

David Bloom, international economist at HSBC James Capel in London, said a switch into two-year U.S. paper from commodities might be a bit too hasty, with the world's three leading economies -- the United States, Germany, and Japan -- set to grow.

"By the second half of the year, commodity prices should start coming back again," he said.

While Bloom said he favored two-year U.S. paper for the short-term, and did not see an interest rate rise at the Federal Open Market Committee meeting at all, German debt was also attractive.

"The safer haven would be Germany because the recovery seems to be a little more patchy," he said.

"Japan seems to be on an upward trajectory, the U.S. is accelerating at the moment but there are still question marks over Germany," Bloom said.