Q4 Commodity Outlook: Tricky Road Ahead as Dollar Strengthens

Commodity markets will continue to be driven by worries about the potential impact of a slowing global economy. A solution to the sovereign debt crisis has still not been found and with governments running out of fresh ideas this has caused tremendous stress on the financial system. Cyclical commodities like energy and base metals have suffered as a consequence while safe haven flows and adverse weather have been the main reasons for gains across precious metals and agricultural commodities.

We believe that renewed dollar strength during September will continue into the last quarter and this could potentially have a dampening effect on the performance of commodities, ensuring a relative flat 2011 performance of the major commodity indices.

Energy: The dramatic spike in oil prices earlier this year has been a major reason for the surprise slowdown in economic activity witnessed during the past six months. The price of Brent crude, which has taken on the role as a global benchmark for a majority of global transactions, has so far averaged 111 dollars in 2011, well above the averages for the previous three years. Despite not reaching the record levels seen in 2008 it has nevertheless already spent more days above 100 dollars during 2011, thereby squeezing private consumption.

Increased demand drove prices higher in 2008 while this time supply disruptions and constraints have been the culprit for higher prices. Libyan oil production will be limited for months while supply disruptions from Nigeria, Syria and the North Sea have ensured higher prices compared with WTI crude which has stayed at depressed levels over the summer.

All of the growth in oil demand is now stemming from Emerging Market (EM) economies and in order to determine future price movements the economic well-being of these economies will be the decider. We expect the price of Brent crude to remain range bound for the remainder of the year between 100 and 120 with an end of year target of 105 dollars.

Precious metals: The rally in gold, which has now lasted for more than 10 years and has returned nearly 21 percent annually, is undoubtedly the world’s most powerful trend. Investors and central banks have all been competing for the yellow metal over the past two years as the global financial crisis has triggered an exodus out of other asset classes into “safer assets”, such as gold and silver.

During the third quarter record high prices led to increased volatility which dented some of the lustre for gold as it became increasingly difficult to trade. As a result we saw investors pulling out of long positions, both in ETFs and futures during August and September and we began to see 100 to 200+ dollar corrections. The super trend however remains firmly intact and only a move below 1,500 could spoil the party for investors holding close to 3,000 metric tonnes through various investment vehicles. We believe that gold may have another push to the upside reaching the magical 2,000 dollar level in early 2012 before a period of consolidation sets in.
Continued volatility could trigger additional margin increases on the major futures exchanges and force some investors to scale back positions even further. We see gold trading in a 1,650 to 1,950 range with an end of year target of 1,900. Silver has gone from being a driver to a follower of gold since the April price collapse. Given the weakened outlook for industrial metals we see silver potentially weakening further relative to gold with the value of one ounce of gold going from 50 to 55 ounces of silver.

Agriculture: Despite record planted acreage this crop year poor weather and reduced quality has led to a reduced U.S. production of corn and soybeans. This has caused a strong rally of the two over the summer in order to force demand rationing through higher prices. This rationing now seems to have begun having an impact on both feed demand and export. On this basis we believe that the prices of soybeans and corn have already peaked and could settle into 13 to 14 and 6 to 7 dollar ranges respectively for the remainder, also given our forecast for a stronger dollar which could dampen exports even further.

Weekly Commodities Update : Commodities in September - What a Mess

Global markets suffered serious setbacks during September as investors’ nerves were tested on numerous occasions. Hopes are now pinned on the fourth quarter which historically tends to support prices but continued uncertainty about the Eurozone debt crisis and the economic slowdown that is impacting the global economy will not go away anytime soon. The commodity area has seen elevated one-sided bets being reduced which leaves individual commodities in a much better position to react to price supportive news.

The three major commodity indices are currently down between seven and ten percent year to date after individual markets suffered heavy losses across the board over the last month, as seen below. Hardest hit has been the base metals sector with the LMEX London Metals Index down 21 percent year to date with copper and nickel particularly suffering heavy losses. The near six percent rise in the value of the dollar during September also hurt the sector, given its inverse relation to commodity prices.

Hedge fund redemptions receiving some attention
 

Many hedge funds have been struggling with their performance this year. The HFRX Global Hedge Fund Index is currently down 7.5 percent year to date and this has lead to increased risk of investors pulling their money out. An example of this was Man Group, the world’s largest listed hedge fund manager, whose share price dropped 25 percent this week as it said clients pulled 2.6 billion dollars during the third quarter. Similar redemptions from others could have an adverse impact on commodities as positions would need to be scaled down in order to reflect reduced levels of assets under management.

Metals stabilising after a week of records
 

Gold is heading for its best quarterly run in at least four decades despite the experience in August, the worst monthly performance since October 2008. Overall the past week in metals has been one for the record books. Silver dropped by 34 percent in a matter of days, its sharpest drop in 30 years. Gold meanwhile corrected by 20 percent from its peak, which has only happened twice before during the last decade.

Copper entered into a bear market having corrected by one third from the February high as hedge funds reversed their positions into shorts for the first time in more than two years. This resulted in the largest quarterly loss since Q4 2008 as concerns over Chinese demand, the world’s largest consumer of industrial metals, had investors changing their perceptions of industrial metals.

What triggered the sell-off?
 

The reasons behind the sell-off are numerous: risk adversity, a scramble to realise cash to cover loss-making positions elsewhere, economic slowdown reducing demand for industrial metals, hedge fund redemptions and not least another margin hike by CME, the world’s largest futures exchange. Added to this there has been market talk about heavy selling by Chinese investors. They have been focusing on the strength of their domestic economies and have been caught out by the slowdown elsewhere.

Since early August gold volatility has been stubbornly high indicating increased uncertainty about its future direction. A new record high at 1,921 was reached on September 6, but already before then (and after) professional investors have been reducing their exposure despite global stock markets going into reverse. Several 100 dollar corrections during the last month added to the unease among investors who had viewed gold as the ultimate safe haven asset.

Risks ahead?
 

It took 18 months to reclaim a new high during the previous two major corrections in 2006 and 2008; investor redemptions from exchange traded funds (ETF) have so far been very limited and as such carry the risk of further selling should that type of investor decide to scale back as well. Lastly and probably most importantly we need to see volatility reduced as excessive volatility poses the biggest risk to gold’s safe haven appeal.

Technically gold held and bounced strongly off its 200-day moving average, currently at 1,532 dollar, and this has returned some of the confidence that was lost during the rout. However, as long as we stay below 1,700 dollars per ounce there will be a risk of testing the support once again. The arguments for holding gold have, if anything strengthened during August so once this nervousness subsides gold could shine once again. Physical demand from a number of central banks has moved up a gear during the sell-off and that should also help cushion any further setbacks.

Oil declines on outlook for reduced demand
 

Oil prices saw the biggest quarterly drop since the 2008 financial crisis as attention shifted from tight supply issues towards slowing demand. Growth across the main oil consuming nations has been slowing and even China has not been able to avoid a slowdown. Most of the major oil trading houses have as a result been slashing their 2012 price forecasts in quite a dramatic fashion. 

So far support levels in Brent crude at 100 dollars have been holding but further signs of weakening economic activity could put this level under some near-term pressure, especially if the dollar continues its recent surge higher. For now though the sector continues its very nervous trading pattern as it tends to react to every little piece of news that hits the wire as traders search for clues about the future direction.

U.S. grain stocks higher than expected
 

Grain markets which have been anything but immune to the carnage over the last month fell further on Friday as a Grain Stocks report from the United States Department clearly showed the impact from reduced demand as both wheat and especially corn stocks were higher than expected while soybean stocks was as expected. The price of corn for December delivery having broken below the 200 day moving average also broke below the uptrend from July 2010 signalling near-term risk of further long liquidation.

Gold Margin Increase Triggers Rout

The past week in metals has been one for the record books. Silver dropped by 34 percent in a matter of days, its sharpest drop in 30 years. Gold meanwhile corrected by 20 percent from its peak, which has only happened twice before during the last decade. Copper corrected by one third from the February high as hedge funds reversed their positions into shorts for the first time in more than two years.

The reasons behind the sell-off are numerous: risk adversity, a scramble to realise cash to cover loss-making positions elsewhere, economic slowdown reducing demand for industrial metals and not least another margin hike by CME, the world’s largest futures exchange. Added to this there has been market talk about heavy selling by Chinese investors. They have been focusing on the strength of their domestic economies and have been caught out by the slowdown elsewhere.

Since early August gold volatility has been stubbornly high indicating increased uncertainty about the future direction. Up until and following September 6, when a new record high at 1,921 was reached, professional investors had begun to reduce exposure despite global stock markets going into reverse. Several 100 dollar corrections during the last month added to the unease among investors who had been viewing gold as the ultimate safe haven asset. 

The rout happened last Friday as rumours about an imminent CME margin hike on the gold futures contract pushed it below 1,700, only to accelerate Monday when Far Eastern investors could react to the new situation. Silver extended the sell-off that began in early May and gold reached but did not breach the line in the sand being represented by its 200-day moving average. 

In our article “Heads up! Gold futures margin could be raised again” from August we argued that the ongoing volatility and daily price swings probably warranted another hike to between 8,200 and 9,000 dollars per contract. On Friday the margin for holding a gold futures contract was raised to 8,500 which means an investor at the current gold price needs to pay 5.2 percent of the contract value to maintain a position. 

Such a margin is historically relatively high and unless we see a further escalation this should probably be enough for now. Technically gold held and bounced strongly of its 200-day moving average, currently at 1,530, and this has returned some of the confidence that was lost during the rout. The arguments for holding gold have if anything strengthened during August so once this nervousness subsides gold could shine once again. 

What are the risks from here? It took 18 months to reclaim a new high during the previous two major corrections in 2006 and 2008; investor redemptions from exchange traded funds (ETF) have so far been very limited and as such carry the risk of further selling should that type of investor decide to scale back as well. Lastly and probably most importantly we need to see volatility reduced as excessive volatility poses the biggest risk to gold’s safe haven appeal.

Commodities Weekly Update : Commodities Sink into Red as Confidence Saps

Riskier assets such as commodities and stocks were seriously shaken this week as the U.S. Federal Reserve failed to lift investor confidence. At its long awaited meeting it delivered the now famous “Operation Twist” whereby it will be supporting the long end of the yield curve thereby attempting to keep borrowing costs low. What spooked the market however was the comment that the U.S. economy was facing “significant downside risks”.

As my colleague wrote after the announcement: “With the Fed launching Operation Twist Bernanke furthermore runs the risk of arriving too late at the party with a solution for the second time in 10 months as his QE2 programme last November came so late that the economy had long rebounded and the programme fuelled a massive commodity rally instead, which ultimately weighed on U.S. consumers in the first half of this year and forced the economy into a halt yet again.” Full text here.

By avoiding a new QE2 style liquidity injection Bernanke at least removed the fear that another round of galloping commodity prices could be on the cards. This could help consumers and manufacturers who have been struggling amid higher prices of anything from copper to gasoline but at the same time confidence is being hit by the ongoing sell-off in equities.

Changing investor attitude towards dollars
The European debt crisis helped the dollar climb to a seven-month high thereby weighing down the whole commodity complex as it became more expensive for buyers using other currencies. Last week the speculative dollar position held by hedge funds through IMM currency futures moved into positive territory for the first time in 14 months showing how the attitude towards dollars has changed dramatically over the last few weeks.

Commodities suffered the worst setback in more than four months on worries that a global recession could hurt demand for metals, energy and food. The Reuters Jeffries commodity index lost 8 percent in the week as every single commodity moved into the red. Interestingly gold, which has otherwise been viewed as a safe harbour amid stormy seas, also took a beating.

Gold falling victim to excessive volatility
Over the last month gold has made a new record high twice but has also been exposed to three 100+ dollar corrections. This has at least near-term reduced the safe haven flows as the increased volatility has made it increasingly difficult to trade and has prompted some gold bulls moving to the sideline to wait for lower prices and hopefully calmer trading conditions. During the same time investors in ETFs and futures have reduced exposure to gold by nearly 300 tonnes to 2,935 tonnes as cash and/or bonds have met increased demand.

LBMA expects gold at 2,019 next November
This week bankers, traders and investors at the gold industry’s largest annual gathering in Montreal predicted that the decade long Bull Run would continue into 2012. The 500 people attending the conference of the London Bullion Market Association predicted that gold would be trading at 2,019 dollars per troy ounce in November 2012. Last year when gold traded at 1,298 they predicted a price of 1,450 at this meeting, a 25 percent undershot from the 1,805 traded this Tuesday when the poll was made.

Having dropped more than 10 percent from the record high support is again being sought with 1,650 followed by 1,600 being the next major levels to look out for. Further dollar appreciation could trigger such a move but the positive long term projections for gold should help cushion any further setbacks.

Industrial metals suffer the most
Metals related to industrial use however have been the main losers with copper, silver and palladium suffering deeper setbacks. Silver lost an unprecedented 20 percent in just two trading days while copper, a gauge for global economic activity, fell into a technical bear market having lost more than 20 percent from the February high. Platinum is trading at the widest discount to gold in almost two decades as recession fears has removed some of the demand from industrial users which normally caters for more than 50 percent of platinum consumption. Investors looking for an economic recovery should watch this ratio closely as platinum has traded at an average premium to gold of nearly 40 percent over the last decade.

Oil markets confined to wide range
Crude oil, having failed to break higher last week, was caught up in the torrent of negative macro-economic news and dropped the most in two months. The surging dollar and the U.S. Federal Reserve’s failure to pull another rabbit out of the hat left traders focusing on reducing exposure. The moves go somewhat against the fundamental background as continued tightness especially in Brent crude, combined with a continued fall in inventories at Cushing, the delivery hub for NYMEX WTI crude, failed to receive much attention.

The overall worry is that demand for energy in the U.S. and China, the world’s two largest consumers, may fall as their economies slow down. These two nations, according to BP Plc, were responsible for 32 percent of global oil demand in 2010 and if adding the 17 countries using the euro this percentage rose to a total of 44 percent.

The civil war in Libya, which removed high quality crude from the market, has now almost ended. Experts on the ground are now predicting that oil could begin to flow in decent quantities much sooner than originally expected. These additional barrels will hit the market at a time where demand is softening and could force OPEC to address their current output levels. They do not want to see a repeat of the price collapse from 2008 to 2009 given the much higher need for revenues to balance their budgets.  

For now the most likely outcome of the market action is one of continued range trading. Brent Crude having been rejected at 117 went looking for support and should find some at 100. Meanwhile WTI crude having revisited the 80 dollar mark will now find resistance at 85 and support at 75.70, the August low.

Grain speculators suffer blowout
Hedge funds and large investors, who up until recently increased their long exposure to soybeans and corn, suffered heavy losses this week as the commodity deleveraging also hurt the grain sector. The price of new crop soybeans which only recently traded at 14.65 dollars per bushel suffered its biggest weekly loss in more than two years touching 12.50, as the surging dollar combined with signs of demand destruction took its toll.

The stronger dollar has led U.S. growers to face stiff competition on the international grain market with Russia still winning the big wheat tenders while Brazil, having seen its currency drop 16 percent, has stepped up its export of soybeans at very competitive prices.

Going for the Gold

The rising price of gold is hardly breaking news; after all it’s been on a parabolic climb for the last several years. However, even though it’s had a meteoric rise, I think we have barely seen the start of just how high the yellow metal will go.

Everyone from individual investors to central banks are snapping up gold hand over fist. And $2,000 may just be a rest stop before the real parabolic move higher.

Denial Is Not Just a River in Egypt

On December 1, 2009, gold closed at $1,197. The same day, I spoke with Larry Kudlow of CNBC about why gold is going to $2,000.

Now this bullish claim is not new coming from me. I’ve been saying this for well over 8 years and battling it out with gold bears on TV and radio, at seminars around the world, in print, and elsewhere, since gold was trading around $450.

The same arguments I have heard over the last 10 years against buying gold, I’m still hearing today. The denial is really sad! You can hardly blame some of these analysts and economists though. Even the chairman of the Federal Reserve, Ben Bernanke, when asked by Senator Ron Paul if he thought gold is money, Mr. Bernanke basically said “No.”

Now with gold close to hitting the $2,000 mark, wouldn’t it be nice to go back in time and be able to buy it at $1,200? Sure, it would! But I think that in a few years when gold is at $4,000, people will be saying the same thing about $2,000. The fact is that adjusted for inflation we need to see gold at about $2,200. 

Back to Bullion

Let’s face it, nothing has changed on the fundamental front for the U.S. dollar. And the global economy is actually more in tatters now than it was when gold moved from $450 to $1,900, and I expect things to get worse.

We still have high unemployment, near-zero interest rates, endless printing of fiat currency by the Fed, and a debt-to-GDP ratio that is mind boggling! Now add in what looks to be the disintegration of the euro, and possibly the end of the entire European Union, and you have all of the elements in place to see gold prices really explode to the upside.

But in my opinion, one factor stands head and shoulders above the rest, and that’s central bank buying.

European central banks have once again become net buyers of gold for the first time in more than twenty years, which is a very clear indicator of how uncertain things are in the currency and debt markets right now. 

Countries such as Mexico, Russia, South Korea, and Thailand have made sizable purchases this year. The reason is clear why these countries are taking this action: They want to reduce their exposure to the dollar. Worldwide, central banks are set to buy more gold this year than at any time since the collapse of the Bretton Woods system four decades ago, which by the way was the last time the value of the dollar was linked to gold.

So far, on a relative basis, the purchases by central banks are small when compared to the size of the global gold market overall. That in turn, is very bullish to me. This level of buying is a complete U-turn for most of these central banks, especially in Europe, who sold gold heavily.

Even the small increase we have seen in central bank buying has helped lift the price of gold by more than 25 percent so far this year, hitting a high of $1,900 on 9/5/11. 

For years I’ve been encouraging people to have gold in their portfolios.

Will there be corrections in gold, certainly. Volatility in gold, and silver for that matter, remains very, very high. The exchanges have tried repeatedly to raise margins in an effort to slow buying, but it’s been about as effective as butter stopping a hot knife.

So is it too late to get in on the gold rush? Not at all!

Golden Opportunities

There are many good ways to invest in gold, including: Gold coins, bullion, key mining shares, and options on futures. Diversification and risk management are key. One of my favorite vehicles for investing in gold is key gold ETFs.

Bottom line is that gold has had an incredible run higher over the last few years. But that could simply be a dress rehearsal for the real show that’s about to begin. As central banks and individuals shift out of fiat currency, one of the few safe harbors is gold. It’s that simple.

So don’t be intimidated by the gold bear; take action and hedge your portfolio against the falling dollar and euro using limited risk strategies like I have discussed.

Yours for resource profits,

Kevin Kerr

Kevin Kerr is a considered one of the best resources on how to trade commodities, futures, and options for the new and advanced resources trader alike. He is co-editor of Global Resource Hunter, a monthly newsletter designed to help you ride the commodity supercycle — an ongoing surge in price of food, energy, metals and more.
Kevin is also the editor of Master Trader, a service meant to use ETF options for gains in any major asset class in the world — stocks, precious metals, commodities, bonds and even foreign currencies — no matter what event or trend is happening in the world!

Weekly Commodities Update : Stronger Dollar Eroding Support for Commodities

Stock markets finished stronger after another volatile weak with especially banks suffering early on before policymakers’ attempts to address the Eurozone fiscal crisis succeeded in reducing some of the stress in the system. The dollar broke higher after having range traded against the Euro for months and the near-term outlook now points towards a stronger dollar which could dampen the demand for commodities as an investment class, especially while the global economic outlook continues to be clouded.

The Reuters Jefferies CRB Index traded lower on the week and is still stuck around a flat performance for 2011. The energy complex had a good week with Brent and WTI crude on top while the majority of commodities saw negative performances with profit taking being the main focus in particularly the agricultural and precious metals sectors after strong rallies in previous weeks. 

Gold Down but Not Out
Investors in gold took some money off the table as the stronger dollar and signs of political will to help the European debt crisis triggered the third 100+ dollar correction within a month. No sign of panic however has been detected and once again the sell-off met new buyers which helped stabilise prices. A continued rise in the dollar could call into question the chance of higher gold prices near term and traders could as a consequence be inclined to book profits faster than previously and ensure that a prolonged period of range trading could be on the cards. The biggest danger near-term however is the size of long positions held through Exchange Traded Funds and futures. Although it has come down by 220 metric tonnes from the August peak above 3,100 tonnes, a move below 1,700 on gold carries the risk of further long liquidation as fund managers look to book profits to offset losses elsewhere.

Spot gold, source Bloomberg

WTI crude rise as release of strategic reserves ceases
The price of West Texas Intermediate rose for the fourth week running and is once again testing the 90 dollar level. The final 1 million barrels from a total of 30.6 million released from U.S. strategic reserves over the last eight weeks has now reached the market. During the same time we have seen inventories at Cushing draw for the seventh week in a row, thereby easing some of the supply overhang at the delivery point for NYMEX WTI crude, which in turn has seen the discount to Brent crude contract. Further upside on both crudes seems limited after the recent run higher as the potential for a stronger dollar and continued nervousness in stock markets should limit any further progress. We anticipate the two varieties to remain within a 10 to 15 dollar range with resistance at 91 on WTI and 117 on Brent. 

Brent crude (front month), source Bloomberg

High corn and soybeans prices trigger demand destruction
The grain and soybean sector posted steep losses this week as focus shifted from the already known tight supply situation to concerns about weakening demand. The monthly “World Supply and Demand” report from the U.S. Department of Agriculture last Monday confirmed the tight supply situation but also highlighted the beginning of a slowdown in demand from exporters, ethanol producers and livestock feed. The liquidation of speculative long futures and options bets on corn and soybeans, which have increased by 50 percent since early August, also played a role in the sell-off this week. The sector had been viewed as immune to the risk adversity which hit other commodities over the summer. The stronger dollar combined with the shift in focus from supply to demand has changed that, at least for now, and could potentially mean that the highest price of the year for new crop corn and soybeans has already been seen.  

Russia, which is expected to harvest 90 million tonnes of grains, continues to undercut prices for large wheat tenders while forecasters made an unexpectedly large increase to their estimate of global inventories due to increased production estimates for Canada, Europe and the FSU. All in all this added downside pressure to wheat prices on both sides of the Atlantic with Chicago wheat trading back down to 7 dollars per bushel.

Weekly Fundamentals - Macroeconomic Turmoil Sent Gold to New All Time Highs

Financial markets had another volatile week as economic data in the US and renewed sovereign debt concerns in the Eurozone continued to shake confidence. Earlier in the week, risk appetite was boosted by better-than-expected US retail sales and Japan's GDP data. M&A news (Google's purchase of Motorola Mobility) sent stock prices higher and in turns boosted risky assets. Sentiment turned sour again in the middle of the week and deteriorated further on Thursday with stocks, commodities (except for gold) and higher-yield currencies facing another big selloff amid disappointing US data. While weaker-than-expected initial jobless claims, housing data and manufacturing index gave further signals that the country may have a double-dip recession, rising inflation pressures indicated it's getting more difficult for the Fed to implement measures to stimulate growth.

The Franco-German meeting failed to come up with solutions to settle the debt crisis. Leaders of biggest economies in the 17-nation region proposed to create a 'true European economic government' which will eventually lead to a common tax and fiscal policies within the Eurozone. Concerning fiscal issues, Germany and France will create a common corporate tax base and tax rate between the 2 countries from the start of 2013. Moreover, they will propose in September the imposition of a new financial transaction tax across all Eurozone members. While the details of the types of taxes were not provided, investors were obviously irritated by the financial transactions tax as the euro and equities plunged after the announcement.

The ECB said that it has recently lent US$ 500M in its 7-day liquidity-providing operation to a bank at above market rates. This was the first time since February that the facility was used. Fears that more banks will seek ECB's funding because of their heavy exposure to debts of Greece and other debt-ridden countries increased and would make the market outlook negative. Concerns over contagion of Eurozone's sovereign crisis have spread to the US. The WSJ said that US regulators are taking a closer look at the US units of Europe's biggest amid concerns that the region's debt problems will spread to the US banking system. The report said that the New York Fed is 'very concerned' about the issue and has been seeking information about the banks' ability to access funds to maintain their US operations. New York Fed President Dudley denied the officials are watching a particular group of banks closely and reiterated that the central bank treats US and European banks 'exactly the same' and is 'always scrutinizing banks'.

Tremendous uncertainties in the economic outlook and banking system in both sides of the Atlantic will persist for some time. Investment banks such as Citigroup and JP Morgan downgraded their forecasts on US growth while Morgan Stanley trimmed its global growth outlook, warning the US and Europe are 'dangerously close to recession'. We expect financial markets will remain fragile in coming weeks.

Crude Oil: The front-month contract for WTI crude oil erased gains made earlier in the week amid worries over US recession. The selloff was exacerbated by the unexpected stock-build. Crude stockpile surprisingly rose +4.23 mmb, to 353.98 mmb as stocks in Gulf Coast surged a huge +6.26 mmb in the week ended August 12. Brent crude was strong despite a similar trend as disruption in the North Sea, Nigeria and Libya supported price. The front-month contract ended the day gaining +0.55%.

Nymex natural gas slipped with price plunging to a 5-month low of 3.843 Thursday before settling at 3.94 Friday. The benchmark contract lost -2.96% on weekly basis. According to the DOE/EIA, gas storage climbed +50 bcf (consensus: +48 bcf) to 2833 bcf in the week ended August 12. Stocks were -175 bcf below the same period last year and -73 bcf, -2.5%, below the 5-year average of 2906 bcf. As far as rig count is concerned, Bake Hughes reported that the number of gas rigs rose +4 units to 900 in the week ended August 19. Oil rigs added +11 units to 1066 and miscellaneous rigs remained unchanged at 8 units, sending the total number of rigs to 1974 units during the week. Directionally oriented combined oil, gas, and miscellaneous rigs fell -13 units to 227, while horizontal increased +15 units to 1138 and vertical increased 13 units to 609.

Precious Metals: With the exception of palladium, all commodities under our coverage jumped during the week. Silver was the best performer, followed by gold and platinum. The strength of these precious metals was attributed to the slowdown in global growth outlook, large fiscal deficits, low interest rate-environment in developed countries, heightening inflationary pressures and political and economic uncertainties. The issues, despite governments' resolutions, will persist (low interest rate-environment will persist for several years) and will continued to support the precious metal complex for some time.

Gold price surpassed platinum price earlier in the month for the first time since December 2008 as demand for safe-haven assets drove investors to the yellow metal from risk assets. In 2008, gold price exceeded that of platinum four times (December 12, 15, 17, 18) and we would not be surprised to see gold trade above platinum more sustainably this time.

While both metals are categorized as precious metals, industrial demand makes up over 80% of total platinum demand (with autocatalytic demand taking up more than one-third of total demand) but it only accounts for around 10% of total gold demand. The 'industrial' characteristic in platinum makes its price movement more synchronized with stocks, oil and other 'higher risk assets'. Therefore, it tends to lose its glitter to gold during economic turmoil and uncertainty. On the contrary, gold is often considered as a store of value and a hedge against inflation. It's especially attractive when global central bankers are competing to devalue their countries' currencies so as to stimulate growth.

World Gold Council released its latest gold demand trend last week. According to the council, total global demand fell in 2Q11 fell -17% y/y in volume terms but increased +5% in value terms. Strong growth in jewelry was offset by a drop in investment demand, especially from ETF and similar products. We believe the apparently underperformance in ETF investment was due to high base effect as ETF demand in 2Q10 was the second large one on record.

Geographically, Indian and Chinese demand grew +38% and +25% respectively in 2Q11 from the same period last year. World Gold Council expects the growth to continue in the second half of the year, thanks to 'increasing levels of economic prosperity, high levels of inflation and forthcoming key gold purchasing festivals'. Other factors supporting gold demand in 2H11 include sovereign debt problem in the Eurozone, downgrading of US debts, inflationary pressures and the for economic growth outlook in developed countries. These factors will continue to support official sectors in remaining net purchasers of gold and are all likely to 'drive high levels of investment demand for the foreseeable future'. 

Weekly Fundamentals - Gold Still Looks Cheap in Inflation-Adjusted Term

Commodities moved with great volatility in the past week, driven by intensifying concerns of US double-dip recession, spreading of sovereign crisis from the European periphery to core economies, speculations of Fed's easing measures and somehow supportive macroeconomic data. During the week, the front-month contract for WTI crude oil plummeted below 80 for the first time since October 2010 while the equivalent Brent crude broke below 100 first the first time since February 2011. Both benchmarks recovered later in the week in tandem with the rebound in equities. Gold remained the best performer as investors fled to the yellow metal for safe-haven investments. The benchmark Comex contract gained +5.54% during the week with price surging to a new record high of 1817.6 Thursday before retreating after the SME announced margin increases. While further correction in likely in the near-term, gold will still be the biggest beneficiary of low interest rates, rising economic uncertainties and a new round of central bank easing.

Earlier in the week, the Group of Seven Nation issued a joint statement, pledging to 'take all necessary measures to support financial stability and growth'. However, this failed to restore confidence and financial market tumbled in response to S&P's downgrades of US' debt ratings. After trimming the credit rating of US debts' from AAA to AA+ on August 4, the rating agency also lowered the AAA ratings of a number of US-backed bonds, including Fannie Mae and Freddie Mac, by a notch to AA+ on August 8. The agency said the downgrade was due to their 'direct reliance on the US government. In a statement in the midday, S&P also warned about the Asia-Pacific outlook, citing 'uncertainties in the global financial market and weakened prospects in the developed economies have further undermined confidence. The potential longer-term consequences of a weaker financing environment, slower growth, and higher risk aversion are negative factors for Asia-Pacific sovereign ratings '.

The market was in a 'risk-off' mode until the Fed announced to keep interest rates low at exceptionally low levels at least until mid-2013 at the FOMC meeting. The central bank also decided to maintain its existing policy of reinvesting principal payments from its securities holdings and will regularly 'review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate'. Although the Fed did not explicitly signal it will adopt QE3, the change of language in the 'extended period' phrase, maintenance of the reinvestment program, inflation expectations and discussion of 'the range of policy tools available to promote a stronger economic recovery in a context of price stability' indicated that the Fed will resume outright asset purchases, should economic outlook deteriorate further. The next key event would be Fed Chairman Ben Bernanke's speech at Jackson Hole on August 26 The market has been speculating that the Chairman will announce further easing policy on that day.

In the coming week, US' data including CPI and industrial production will be in focus as the outcomes will be deterministic of Fed's monetary policy. The BOE and the RBA will also release minutes for the August meeting. We expect both central banks to show worries over rising downside risks on global economic outlook.

Energies: EIA, OPEC and IEA released their latest oil demand forecasts last week. In light of economic slowdown and heightening global uncertainties, oil agencies revised modestly their outlooks for oil demand growth. The OPEC lowered the demand estimates for both 2011 and 2012, the IEA trimmed this year's outlook but raised next year's and the EIA raised demand from 2010-2012 but the size of growth in 2011 was lowered as a result. All 3 agencies warned of the great uncertainty in global economic outlook. The IEA stated that 'concerns over debt levels in Europe and the US, and signs of slowing economic growth in China and India have spooked the market and raised fears in some quarters of a double-dip recession'. The OPEC cited 'dark clouds over the economy are already impacting the market's direction...The potential for a consequent deterioration in market stability requires higher vigilance and close monitoring of developments over the coming months'. Together with reduction of the price forecasts, the DOE/EIA said that 'there is significant downside risk for oil prices if economic and financial market concerns become more widespread or take hold'.

Notwithstanding weaker headline growth forecasts, demand in non-OECD countries remains resilient and its share of total global demand is indeed revised higher. For instance, the EIA's estimate of non-OECD as a percentage of total oil demand was upgraded to 48.02% in 2011 and 48.48% in 2012, compared with 47.91% and 48.78% respectively in July's projections. The OPEc also forecast non-OECD as a percentage of total oil demand to increase to 47.67% in 2011 and 48.43% in 2012, compared with July's projections of 47.62% and 48.38% respectively. China will continue to be the biggest oil consumer in the emerging market. Therefore, the economic developments in China and emerging markets will be more determinative for oil prices in coming year despite short-term volatility.

Nymex natural gas price rose +3.02% last week as inventory increased less than expected. Storage climbed +25 bcf to 2783 bcf in the week ended August 5, compared with consensus of a +37 bcf gain. Stocks were -197 bcf below the same period last year and -80 bcf, or -2.8% below the 5-year average of 2863 bcf.

In the Short-Term Energy Report, the EIA forecast that total natural gas consumption will increase +1.8% to 67.4 bcf/day in 2011, driven by industrial and electric power demands, and then to 67.8 bcf/day in 2012. Gas production is expected to increase +5.9% y/y to 65.5 bcf/day this year and then by +0.9% to 66.1 bcf/day in 2012. Domestic production has been so strong that it contributed to net exports.

During the week, the Baker Hughes also reported the number of gas rigs increased +3 units to 896 units.

Precious Metals: Gold extended its rally last week, recording the biggest weekly gain since 1Q09, amid global economic uncertainty and speculations of Fed's QE3.The metal surged to a new all-time high of 1817.6 Thursday before sliding after the CME Group announced margin increases. The CME raised the initial margin requirement to 7425 per contract from 6075 and the margin for hedging to 5500, up +22.2% from 4500.

While gold's correction may continue next week, CME's margin adjustment would not reverse the metal's uptrend. Indeed, the market only used that as an excuse to take profit from gold's recent exponential rally. Gold's accelerated rise might have been a bit overextended in the near-term. The chart below shows that the metal's close on Friday has already exceeded the upper 3 standard deviation. It's reasonable for the metal to have a correction before resuming the rally.

The market has been talking about gold price bubble as the metal has risen more than +26% since the beginning of the year and almost 80% of the gain was made over the past 6 weeks. Nominal gold price has indeed risen to a record high and exceeded levels in 1980. However, after inflation is adjusted, gold price remained -20% below those levels. While many people also compare the current economic situation with the one in 2008 when Lehman Brothers collapsed, the current pattern of gold price is more similar to the period from 3Q07 to 1Q08. If gold is to resemble the movement at that time, price will need to rise +20% more as the metal soared +50% back then.

Commodity Weekly : Commodities Stabilising after the Rout

Elevated volatility across all major asset classes continued this week as the debt crisis on either side of the Atlantic, combined with slowing economic activity, left everyone on the edge. The market is currently trying to work out whether some economies will move back into a double dip recession which will be bad news in general for equities and commodities.

The chart below gives an idea of the movements in some of the key markets since the Federal Reserve ceased quantitative easing. Riskier assets like stocks and oil have suffered while investors have moved into gold and the Swiss Franc. The Swiss Franc is now generally believed to be overvalued by 40 percent and the implications are clearly evident by the traffic queues as people  drive out of  Switzerland to to do their shopping in Germany and France. How the Swiss Central Bank is going to deal with this crisis has been the source of much speculation and one that eventually caused the SFr to weaken late in the week.

 The Reuters Jefferies CRB index recovered from earlier losses and ended the week almost unchanged as gains in precious metals and agriculture offset losses in energy and base metals. The weekly “Commitment of Traders” report which gives an overview of how hedge funds and large investors are positioned is due Friday and this will help shed some light on the scale of position reduction that occurred last Tuesday when panic was widespread. CME the world’s largest futures exchange registered a new record in volume that day with some 25.7 million contracts traded across all asset classes with gold registering an individual record.

WTI crude corrects by one third before bouncing
The price of WTI crude crashed to 75.71 on Tuesday and in that process corrected by one third from the May highs and also briefly moved below the 201 average at 80 dollars. Long liquidation combined with fear about a double dip recession drove prices lower before recovering. Right now the market has run out of confidence in higher future prices, which until recently drove the market up and only further consolidation can remove some of the fears.

Brent crude has held up much better primarily because the price reflects demand from emerging economies and lower speculative involvement than what has been seen in WTI crude. It briefly dipped below 100 dollars before recovering strongly with a potential move back above 110 signalling further strength ahead.

OPEC members have so far been quiet when it comes to what price level could trigger a production response. Barclays estimates that Saudi Arabia now, due to higher spending, requires an oil price close to 100 dollars in order to break-even. This, as they say, should help create a floor under the market going forward.  

Gold reached parity with platinum
The price of gold reached another new nominal record high above 1,800 dollars and headed for its best weekly performance since January 2009. It has now rallied the past six weeks with investors flocking to gold while the financial hurricane has been causing widespread damage across other markets.

As gold climbed new peaks silver could not keep up and together with platinum had to accept being left behind. The ratio between gold and silver reached the highest level in six months and the gold platinum ratio briefly reached parity for only the third time in fifteen years. As the chart below shows, on the previous two occasions parity was reached, platinum responded with a twenty percent outperformance during the following months.

Markets calmed down towards the end of the week, with star performers like SFr, Yen and gold running into some profit taking, also on worries that further political initiatives could be announced over the weekend. Investment flows into gold ETFs over the last couple of weeks have equalled that of the previous seven months combined and speculative investment in gold has continued to rise towards previous records.

Gold margin increased – more to come?
The CME which runs the gold futures contact in New York raised the margin for holding a contract of 100 ounces by 22 percent to 5,500 dollars. This still represents only 3.1 percent of the contract value and given the current intraday volatility further margin hikes can be expected, thereby ( at least short term), reducing the upside potential as some traders may have to scale back their exposure. However, physical demand and fundamentals which are solid continues to support and given the risk of further intervention in SFr and Yen many investors look to gold as the only alternative amid all the uncertainty.

Crop report surprise sends prices higher
Having been almost immune to the carnage taking place in other sectors and markets the relative calm in the grain and soybean sector was somewhat broken on Thursday.  In its latest report, the U.S. Department of Agriculture revised down the yield on the new crop. During July parts of the Midwest, the main growing region saw some of the hottest weather for half a century and the crop has been suffering as a consequence. The price of soybeans and especially corn responded by rallying strongly thereby signalling higher food costs over the coming months. Corn is currently the top performer of 2011 having risen 27 percent, some three percent more than gold and silver.

Wheat supported by feed switch from corn
Wheat prices, despite the report being neutral, also rose on a spill-over effect from rising corn prices. Lower production and increased feed demand were offset by lower export expectations. Wheat supplies are still ample with increased production and export from Russia making the international market for large tenders very competitive.

With the price difference between corn and wheat for December delivery almost removed the wheat market should continue to be supported from expectations that livestock producers will switch to feed wheat instead of high-priced corn. The below chart is the ratio between wheat over corn and it shows the phenomenal outperformance of corn over the last six months.

Commodity Update from a Sea of Red

The chart below tells us everything we need to know about the current state of the commodity market. The barage of market unfriendly news over the last few weeks has turned into a rout with investors scrambling to reduce exposure across the board in order to free up cash needed to cover margins elsewhere. 

 The two sectors that continue to bear the brunt of the selling are energy and base metals as the outlook for demand is being reduced on fears that some developed economies are slipping back into recession.

Weather related issues in the U.S. and elsewhere have limited the sell-off in several agricultural products with speculative positions being held at reasonably low levels compared to previous corrections in the sector.

Gold is the only commodity that stands out as investors looking for safe havens have nowhere else to turn. Even silver has suddenly just become another industrial metal with investors unwilling to commit to it given its recent history of wild corrections.

Investors have been moving into gold on a grand scale and the next chart shows where investors in Exchange Traded Products have been putting their money.  According to JP Morgan investors have over the last year increased investments in gold to such an extent that the yellow metal almost counts for 66 percent of all investments in ETPs and has risen by USD 42 billion over the last year. On top of this, recent data from the Commodity Futures Trading Commision shows that futures investments in gold have risen to almost 25 million ounces. All in all this adds up to almost 3,000 tonnes currently invested in gold through futures and ETPs. This is the only cloud on the gold horizon near term as escalating risk reduction could end up impacting gold as well.

WTI crude has now corrected by one third from its 2011 high and trades below the 2010 average. Brent crude is holding on to three digits for now as the spread to WTI has been widening further. The  pressure from speculative long liquidation is hurting WTI the most given that's where most of those investments have been placed. Up until recently, investments in commodity index funds accounted for 800 million barrels of energy. Added to this an additional 300 million held through futures gives an idea of the scale of liquidation that we have seen.

As long as this liquiditation continues it will make no sense to try calling a bottom but as we are moving closer to several oil producers' break even levels some verbal intervention could be on the cards soon.

Finally all three major commodity index funds are now down by five percent year to date with the SP GSCI, comprising 60 percent in energy, having suffered the most over the last week.

Speculative positions reduced ahead of the turmoil

Hedge funds and large investors cut their total long futures position by 2.5 percent to 1,27 million lots last week. As the data was compiled last Tuesday it will not have taken into account the impact of the turmoil that hit the markets later that week.

It did however already then show the trend that continued over the week as energy exposure was reduced and precious metals exposure was increased.

WTI Crude futures positions were cut by a combined 10 percent on the ICE and NYMEX exchanges, the biggest weekly reduction in more than six months. The carnage that followed later in the week will undoubtedly have reduced exposure even further on growing concern that lower economic activity will cut energy demand. Heating oil and gasoline long positions were reduced by 13 and 6 percent respectively

Investors increased their gold futures positions by 5 percent to the highest level since October 2010. Silver, platinum and palladium also saw net inflows as the scramble to park cash in something safe continued and probably would have escalated further in the days that followed Tuesday.

The other sectors saw only small changes with the grains sector having so far been immune to the turmoil as weather related issues have remained the main focus.

Background information: The Commitments of Traders is a report issued by the Commodity Futures Trading Commission every Friday with data from the previous Tuesday. It comprises the holdings of participants in various U.S. futures markets split into "commercial" and "non commercial" holdings. The non commercial or speculative holding are typically institutional investors such as hedge funds and CTAs.