Commodity weekly: Focus shifts to commodity driven inflation fears

Inflation worries are beginning to attract attention, after a week where stocks and commodities rose while euro zone debt fears receded on successful bond auctions from some of the zones most economically fragile members.

The four percent surge of the Euro versus the dollar, which up until Thursday mostly looked like a short covering rally, gathered additional speed following ECB presidentJean Claude Trichet's tough inflation remarks. They seem to have increased the chance of a rate rise much earlier than the market may have been anticipating. European inflation rose to 2.2 percent in December, the fastest pace since 2008 and is now above the ECB's ceiling of 2 percent.

The leading Chinese stock market index erased the gains for the year after an announcement from the People’s Bank of China of another bank reserve rate hike. This will be one of the themes that could dampen the expectations for higher commodity prices in 2011. China's consumer prices rose to 5.1 percent in November, the highest since 2008, on surging food costs.

Commodities, of which many had seen retracements during the first week of January, got back in gear with the Reuters Jeffries CRB index racing ahead and almost reaching a fifty percent retracement of the 2008 to 2009 sell off. Strong rallies among agricultural and energy products left the index 2.3 percent higher at the time of writing this report.

 Energy prices recovered from the bout of selling during the first week of January on the back of various supply disruptions. A report on the Gulf of Mexico leak last year could herald a new and more expensive era for offshore drilling with some projects being delayed as a consequence, thereby reducing supplies to the US market.

European Brent crude looks set to be the first to test the 100 dollar level as it continues to trade at a steep premium over WTI crude. This week it touched 98.85 per barrel with the premium over March WTI rising to six dollars. Supply disruptions and cold weather in Europe combined with high inventory levels at Cushing, the delivery hub for WTI crude, has caused this dramatic widening.

 Discussions are ongoing about whether the price of Brent crude is a better reflection of the current global demand situation with WTI crude's status as the global benchmark being increasingly threatened. What seems to be clear is that global demand rose strongly during the last quarter of 2010 and projections for growth in 2011 still point towards a global increase in demand. With excess capacity OPEC is in no hurry to turn up the tap and holds the key on how the price will behave over the coming months.
The ninety dollar level continues to be the pivot for WTI crude with the recent highs at 92.60 providing resistance while support can be found at the December and January lows at 87.10.

Silver and gold have struggled to gain some traction during the last couple of weeks. Reduced sovereign debt concerns, stock market gains and a shifting focus toward cyclical commodities, such as energy and base metals, have removed some of the strong support seen during the previous six months. The speculative long position in both metals has seen a continued reduction over the past three months while investments through ETFs have also seen a reduction, albeit a small one.

Silver has underperformed gold by three percent recently and is currently stuck in a 28 to 30 dollar range while gold is trading in a range between 1,350 and 1,400. A break below those two lows increases the risk for additional position squaring.

 The world agricultural supply and demand report from the USDA on Wednesday triggered another round of price rises for corn, soybeans and cotton as global stock levels continue to dwindle. Stocks to use ratios fell to a fifteen year low for corn and a thirty year low for soybeans. Strong demand for ethanol now take up nearly 40 percent of the US corn production and it is estimated that this demand will only begin to suffer should corn prices move above USD 8 per bushel, some 25% higher than current levels. Strong expected demand for soybean oil will leave soybean stocks at the lowest levels for thirty years and rationing or higher prices to curb demand could be the result.

 From a food security point of view the report did have some positive news. Rice and wheat are two of the most important cereals with rice being the stable diet for billions of people in Asia. The USDA increased its harvest forecast for rice and cut the demand outlook while the wheat market is amply supplied. Wheat as consequence has underperformed corn by more than five percent since year end, a trend that could continue over the coming months.