Weekly Commodity Update: Stress tests, earnings drive commodities

Ole S Hansen, Senior Manager, Saxo Bank

Market activity this past week has primarily been driven by the U.S. earnings season and the wait for the outcome of the European bank stress tests.

Corporate USA generally delivered Q2 results at or above market expectations which in turn kept stock markets supported. On the flip side FED Chairman Bernanke said that the economic outlook remains unusually uncertain, but was ready to act. With midterm election coming up continued soft US numbers could trigger some additional policy action. 

Meanwhile in Europe the long awaited release of the European bank stress test kept the market guessing about the outcome. Skepticism about the usefulness of the report emerged as the important questions might not be asked: how banks will perform should a weak nation be forced to realign its debt and what would happen if the recession deepens. A credible number of failures among the 91 banks being tested needed to be the result, otherwise the whole exercise would suffer the risk of backfiring leading to renewed risk aversion.

Commodities had a generally quiet week with the Reuters Jefferies CRB gaining one percent primarily on the back of a strong rally in copper, crude and sugar. Sell offs in Cocoa, coffee and corn limited the upside gains. The index has now rallied eight percent to 267 from the May low but will be finding resistance towards 270.

The International Energy Agency, who is an energy adviser to most of the world’s biggest economies, said that China had overtaken the US as the world’s largest consumer of energy. In their calculation all forms of energy such as crude oil, nuclear, coal, natural gas and renewable sources were used. Just ten years ago Chinas total consumption was just half the size of the US and it highlights the phenomenal speed of the economic progress of that nation but also how important a factor they are in determine the cost of various energy sources.

When it comes to crude oil demand the U.S. is still well ahead as they consume an average of 19 million barrels a day compared to China's 9.2 million barrels a day. China's power production relies heavily on coal which accounts for 80 percent of its production. Still China's oil demand rose to a fresh record high in June and is ten percent above the same period last year.

Crude Oil has gone into a summer lull trading inside a relative tight range and primarily taking direction from outside markets such as the dollar and stock markets with the above China story also having a bit of positive impact.
Meanwhile in the US crude oil inventories unexpectedly rose last week increasing the doubt about a recovery in consumption. Inventories at Cushing, the delivery hub into NYMEX rose to 37.1 million barrels, less than 1 million barrels short of the previous record at 37.9 back in May. Demand for VLCCs (Very Large Crude Carriers) has picked up again after recent surplus of tonnage has been putting charter prices under pressure. Operators of super tankers are still complaining about little or no profit being made at current subdued prices.

Crude oil has now spent the past couple of weeks trading sideways as the speculative long position remains pretty small at 35,000 which is small change from the 130,000 lots seen before the long liquidation during May. The dollars seven percent move lower during the past couple of weeks have not had any major positive impact on prices leaving some doubt about the ability of the market to move much above USD 81 near term. 

The second tropical storm of this season named Bonnie is now on route to the Gulf of Mexico after crossing the Florida Keys. This is delaying BP’s attempt to plug its wrecked Macando well by at least two weeks as ships working on the relief well will have to be moved for the duration. The storm is expected to reach the site on Saturday and any pick up in strength will be watched closely.

Support is just below 75 followed by 72.50 while resistance can be found at 80.9. This is the 50 percent retracement of the May 92.18 to 69.62 sell off on the WTI contract for September delivery.

Gold continues to trade close to 1,200 having seen some profit taking during the week which at one stage drove the price down to 1,175, the trend line support from the 2008 low. The speculative long position on Comex continues to be reduced in line with weaker price action and this week saw the first small reduction for several months in the amount of gold invested in ETFs.

Most investors look willing to sit this correction out holding on to their positions. Only a sustained move back below 200 day moving average at 1,146 could trigger a more aggressive round of long liquidation. Resistance can be found at 1,225 followed by 1,250.

Headlines from the Cocoa market brought back memories of the 1983 film “Trading Places” where two guys cornered the orange juice market and in process broke the Dukes. A London hedge fund called Armajaro specializing in Cocoa and coffee last Friday took delivery of an astonishing 240,000 tons of Cocoa from the London futures exchange. This has caused a ripple in the market considering it amounts to seven percent of annual global production and being the biggest delivery from the LIFFE exchange since 1996.

Mr. Anthony Ward nicknamed “Choc finger” because of his previous record as a major player in the London cocoa market had through the hedge fund been building up a huge position in the July futures contract and when the market realized that this position was not going to be closed or rolled into the next month a mad scramble to cover short hedging positions drove prices higher. The July cocoa contract settled at 2600, a 33 year high, after having rallied 25 percent since April.

The reason behind the move can be found in the fundamental outlook for cocoa with the market having been in a deficit for the past four years amid worries about a decline in production from the Ivory Coast which accounts for 40 percent of global production.

Whether Mr. Ward will be successful or has bitten off to large a chunk, which might be hard to swallow, remains to be seen. So far they are sitting on a GBP 80 million paper losses from the settlement price last Friday. This has come from an eight percent sell off since then and the fact that the new front month of September already traded at a discount to July. The near month continuation chart below shows that the price has broken down through the 200 day moving average at 2,272 leaving it potentially exposed to further losses.