Commodity markets have struggled to maintain the momentum from December with several markets seeing corrections during the first few trading days.
The all important market driver, the US stock market, kicked off the year with a new two year high on the back of economic data that continues to improve. Meanwhile, in Europe worries about the sovereign debt situation continues to attract attention with the cost of insuring Greek government debt rising to the highest level so far. This has helped the dollar rally 3 percent versus the euro thereby reducing some of the support for dollar based commodities.
The Thomson Reuters/Jeffries CRB index began the year with losses across the board as the speculative position size has left the sector prone to corrections. It is also worth noting that the index returned an impressive 10 percent during December so short term caution has pushed the overall expectation for 2011 to the back of investors' minds for now.
The beginning of January is the time for the annual rebalancing of index funds such as S&P GSCI and DJ-UBS. Every year they adjust their weightings of the different commodities based on various measures of which the performance the previous year is the most important. The major impact of this exercise generally tends to support commodities that have fallen during the previous year while strong performers will attract some selling.
The rebalance which takes place from Friday January 7 until the following Thursday will see a noteworthy inflow of approximately 2.6 billion dollars into natural gas. The energy complex as a whole should attract 4.1 billion while grains and soft commodities, should see outflow of 2.7 and 1.1 billion respectively. The change in metals is one of a slight reduction with flows into gold, zinc and aluminum offsetting outflows from silver, copper and nickel.
As these changes are well publicized in advance, the actual impact once it begins is always questionable but nevertheless highlights the dramatic differences in performances seen during 2010.
Most of the major research houses and commentators expect another strong year for commodities as cyclicals like energy and base metals will perform amid shrinking inventories and increased economic activity, while some food commodities like corn will be supported amid worryingly low global inventory levels.
This has resulted in 2011 beginning with speculative long futures positions across U.S. exchanges at a record high of 1.85 million contracts. From the chart the most noticeable sector is the grain and oilseeds with corn and soybeans alone counting for 708.000 lots while the energy sector disguise a four year high position in WTI crude due to a large short position in natural gas. Beginning a year at such elevated speculative levels carries a risk of corrections as traders are reluctant to accept loss making positions until some traction has been achieved.
The UN FAO released their December update to the world food index and it showed that global food prices hit a record high last month surpassing the levels seen during the 2007-2008 food crises. However, the cereal component which contains wheat and rice still sit some 14 percent below the 2008 peak. These two cereals are the most important staples with rice alone feeding three billion people in Asia and Africa.
Sugar, which trades at a 30 year high, has been the main driver behind the index reaching the record level but does not attract the same importance from a food security point of view. It nevertheless highlights the risk of food inflation which will be a returning theme for 2011. Especially in emerging economies where it is currently running at ten percent and is set to increase further over the coming months.
WTI crude oil has begun the year hovering around 90 dollars which is viewed as being center of a potential twenty dollar trading range. The speculative long is at a four year high which at this time of year plays an important role as a correction is bound to trigger some additional selling. Fundamentals for the year ahead are pointing a picture of increased demand but also one of plenty available excess capacity, with OPEC sitting on 5 million barrels per day.
The market will be watching the continued progress of the US economy and also the potential adverse impact on continued monetary tightening in China. During December oil demand from US, the worlds' largest consumer, breached 20 million per day for the first time since February 2008. Inventories at Cushing, the delivery hub into NYMEX WTI crude, is approaching 38 million barrels, the previous record from six month ago. This excess supply has helped put the front month under some pressure relatively to other crude oil products like Brent Crude.
Technically the WTI crude contract for February delivery has established a small range either side of 90 dollars. Warning signs of additional corrections will become apparent on break below the December low at 87 which also corresponds with the previous high back in April 2010.
Silver, which rallied the most in 2010, has had a very shaky start to 2011 falling by seven percent at the time of writing and in the process breaking the uptrend from August last year. Investor demand through ETF investments were the main driver during 2010 as the fundamental outlook unlike gold and platinum did not offer much support. The impressive outperformance over gold during the second half of 2010 has come under some pressure these past few days with the annual rebalancing being used as one explanation.
Technically should the correction lead to a break below 28 dollars the next major support level will be 24.90 the 38.2% Fibonacci retracement of the 2010 rally.
Turning to the grain and oilseed market, the USDA will issue four important reports on Wednesday January 12 and they could set the tone for trading over the coming weeks. With lack of any demand rationing seen so far in corn it is expected that the forecast for 2010/11 ending stocks will continue to point towards the tightness that has supported prices over the past few months. Poor weather in South America is expected to have had an impact on the Argentine soybean production which in turn could divert more global demand pressure towards the US market. A wait and see approach is currently being adapted by the market with trading having been fairly subdued so far.
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