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.