Commodity Weekly: A strong comeback for commodities

Commodity markets have bounced back strongly after the carnage caused by risk adversity in the wake of the Japanese earthquake.
The big losers of last week have turned into big winners this week with attention now firmly on potential supply disruptions from continued geopolitical uncertainty. Military strikes in Libya have intensified and unrest elsewhere in the region continues to attract buyers of oil. The radiation risk in Japan combined with continued aftershocks is still causing major problems and hindering the reconstruction process, which is estimated to cost Y25,000 billion ($309 billion) compared with Y10,000 billion after Kobe.
In Europe the sovereign debt crisis returned to the front pages with the Portuguese government stepping down after failing to pass a deficit reducing budget. It is now very likely that Portugal will request an international bailout in the coming days. The immediate risk is one of contagion with Moody’s cutting the rating of 30 Spanish banks.
The DJ-UBS index, which tracks 19 commodities with 1/3 exposure to each of the three major sectors energy, metals and agricultural, has risen 3% over the last week.

 Silver outperforming gold - again
Silver has now rallied 12% from the lows last week reaching a new 31 year high in the process. Investors have returned in full strength after the recent setback as they look for alternative investments amid the ongoing concerns about Libya and Europe’s debt crisis. Gold on the other hand continues to find it very tough breaking into new territory with sellers continuing to emerge on any rallies. Given the strong performance by silver and general amount of uncertainties around, new highs will probably be seen eventually.

Sharp increase in oil prices despite lower Japanese demand
The price of WTI crude oil has also moved sharply higher over the past week as supplies from Libya remain off line. Lingering doubt persists about Saudi Arabia’s ability to meet the shortfall, given the difference between high quality North African oil compared to the heavier and lower quality Saudi oil. Reduced demand from Japanese refiners of some 1.3 million barrels per day has so far received limited or no attention.
We have yet to see any global demand destruction from the recent events and with economists still expecting synchronized growth in emerging markets and developed markets prices should be supported in the months ahead. This is also the reason why various investor surveys continue to highlight the energy sector as potentially the best performing one during 2011.
During the recent 10 dollar sell off we only saw a limited reduction in the speculative long WTI crude position among hedge funds and large investors, a clear indication that it takes more than that to shake the bullish view on the sector.

 The U.S. market continues to be well supplied with inventories rising for a third week with overall demand increasing to 19.3 million barrels a day, some 21% of total global consumption. Gasoline consumption rose by 2.8% to 9.07 mbd and is clearly not showing any signs of slowing down despite the average price at the pump being 28% higher than the 2010 average.
Grains higher after speculative washout
The agricultural sector which experienced the biggest wash out also saw the strongest come back this week with the DJ-UBS grain sector rising by nearly 8% on the back of strong comebacks for corn and rice. Why did corn drop by 18% in a matter of weeks give the strong fundamental outlook for this crop?
The speculative build up of positions over the last six months probably caused most of the selling as investors had to reduce exposure towards riskier assets. This resulted in the grain sector seeing positions being scaled back by 69,000 lots last week and since early February the total reduction has been 232,000 lots as better news on crop forecasts began to reach the market. It does highlight the risk of what happens when the speculative bow gets strung to hard, something that the investor needs to take into account when planning his allocation.

Prospective planting report setting the tone
The overriding focus in the days ahead will be a March 31 report from the U.S. Department of Agriculture showing planting intentions among U.S. farmers. The Prospective Plantings Report will give the first indication for the 2010/11 crop outlook. This annual battle for acreage is currently expected to benefit corn and soybeans as rising prices make these crops more profitable.
The price of wheat has struggled to recover with investors failing to respond to the 30% price collapse since early February. The U.N. Food and Agriculture Organization sees global wheat production for 2011 season reaching 767 million tons, up 3.4% from last year. This will primarily be led by a possible 33% jump in Russian output as the country recovers from the devastating drought last summer.