Profit taking has set in across the major markets as the dollar has regained some lost ground. Speculation grows the Bank of China will raise interest rates again.
Sovereign debt worries came back to haunt the eurozone with the peripheral nations suffering huge losses on their government bonds as yield spreads over German government bonds rose strongly. The credit worthiness of Irish government bonds plunged with the ten year yield rising strongly before falling again Friday amid talk of a European Union led bailout like the one Greece received earlier this year. These worries weighed on the euro resulting in a comeback for the dollar which had been sold ahead of the quantitative easing announcement from the US Federal Reserve.
The stronger dollar initially failed to halt the commodity rally seen up until and after QE2. What changed this sentiment, at least for now, was another strong reading on Chinese inflation. On Friday this resulted in a 5.2 percent tumble in the Shanghai stock index as speculation grew that the Bank of China wouldl raise interest rates again. This would be in order to cool the economy and prevent a bubble like situation in certain sectors to develop further.
Another factor to impact commodities this week was a round of margin increases imposed by US exchanges with the most dramatic impact being on Silver and Sugar where margins were raised by 30 and 65 percent respectively. Silver dropped 11 percent on the news while Sugar plunged 14 percent as speculative long positions where scaled back in order to meet the increased margin payments.
Whether these events will lead to an end of year risk off scenario is too early to tell. It may, however, change the investor’s views on individual markets where some have been driven by the overall eagerness to diverge and place hedges against a falling dollar. Some commodities have seen price rises that fundamentals do not support and they could suffer as consequence. Others will find support relatively quickly and will be give investors another chance to join the longer term trend higher.
At the time of writing the Reuters Jefferies CRB index was 0.7 pct lower on the week as the agricultural sector ran into profit-taking, led by Sugar, Rice and Corn. The energy sector showed strength early on but succumbed to profit taking despite another draw in US inventories. Copper had a good week despite worries about the Chinese rate hike which could dampen demand among the world’s largest consumer.
Gold and silver made new highs, reaching 1,425 and 29.36 before the above mentioned factors triggered a round of profit-taking. The week has generally been characterized by increased intraday volatility with the reversal on Tuesday being particular brutal. Whether this increased volatility is the early signs of end of year position squaring remains to be seen. For now we have not seen any major support levels give way but will keep a close eye on support at 1,350 followed by 1,315 on gold.
Crude oil rose to 88.63, a two year high, continuing the rally that began last week when Saudi Arabia shifted their upper comfortable price level to 90 from 80 dollars previously. Total speculative long positions in crude held by money managers such as hedge funds, commodity pools and commodity trading advisors reached a new record high as of last week and is set to increase further this week.
The dollar strength, combined with the Chinese applying the economic brake further, comes at a tricky time as it increases the risk of positions being scaled back. Fundamental news has been supportive as the inventory overhang in the US has begun to shrink leading the way for potentially higher prices next year as the global economic outlook continues to improve.
No major position adjustments are expected unless we break back below 84.50 which could signal a return to the October range between 80 and 85. Resistance is called at 90 which represents a 50 percent retracement of the 2008/09 sell-off.
US grain markets also ran into profit taking this week. This came despite a USDA report earlier in the week which once again revised down output expectations. The rally in Corn stopped at 6.17 per bushel as profit taking surfaced. Apart from the dollar impact it was also helped by the belief that US farmers may boost planting next year thereby easing global supply concerns. The USDA forecast a global production deficit of 18.8 million tons this year. The biggest threat to current prices is the continued large speculative position which is holding above 2 billion bushels and could trigger a sell off should longs decide to exit ahead of year end.
Technically, the corn contract for March delivery should find support down towards 5.40 which would close out the gab from when the market spiked higher back in October.
The vertical ascent seen in sugar over the past few months came to a halt Thursday as the US futures exchange raised the margin for holding a sugar future by 65 percent. This comes after a 130 percent rally from May brought prices up to a new record high at 33.40 cents per pound. Robust consumer demand combined with uncertainty about India’s export intentions had buyers running scared triggering ever higher prices. The 17 percent reversal over a few hours reminded investors once again about the liquidity concerns that goes with investing in such markets.
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