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.