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.

Gold Margin Increase Triggers Rout

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 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.

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 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 the future direction. Up until and following September 6, when a new record high at 1,921 was reached, professional investors had begun to reduce exposure despite global stock markets going into reverse. Several 100 dollar corrections during the last month added to the unease among investors who had been viewing gold as the ultimate safe haven asset. 

The rout happened last Friday as rumours about an imminent CME margin hike on the gold futures contract pushed it below 1,700, only to accelerate Monday when Far Eastern investors could react to the new situation. Silver extended the sell-off that began in early May and gold reached but did not breach the line in the sand being represented by its 200-day moving average. 

In our article “Heads up! Gold futures margin could be raised again” from August we argued that the ongoing volatility and daily price swings probably warranted another hike to between 8,200 and 9,000 dollars per contract. On Friday the margin for holding a gold futures contract was raised to 8,500 which means an investor at the current gold price needs to pay 5.2 percent of the contract value to maintain a position. 

Such a margin is historically relatively high and unless we see a further escalation this should probably be enough for now. Technically gold held and bounced strongly of its 200-day moving average, currently at 1,530, and this has returned some of the confidence that was lost during the rout. The arguments for holding gold have if anything strengthened during August so once this nervousness subsides gold could shine once again. 

What are the risks from here? 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.

Commodity Weekly Commodities Sunk by Growth Worries

The outlook for global growth is deteriorating, partly as a consequence of rising food and energy prices, and risk appetite has suffered as a consequence.

Carnage in currency and bond markets spilled over to equities and commodities this week. The world’s most followed equity index, the S&P 500 index, dropped below its 200-day moving average erasing all of its 2011 gains in the process. Investors looking for safety scrambled into the Swiss Franc and Yen before the central banks of the two nations had enough and announced measures to curb further currency appreciation. In commodities gold made a new nominal record high as investors and central banks continued to increase exposure to the yellow metal.

The commodity sector got hammered with the three major indices moving back into negative territory for the year with the base metals and energy sectors especially suffering heavy losses. The impact on global activity of a 40 percent rise in Brent crude from the 2010 average is now clear and the fragile economic recovery has not been able to cope with the price rises over the past six to nine months. Adding to this the debt crisis in U.S and especially Europe commodities in general will have a bumpy ride in the weeks ahead.

As the European debt situation continues to frighten investors they now also have to contemplate the risk of a double-dip recession in America. A third round of quantitative easing, which up until recently was dead and buried, could resurface thereby supporting tangible assets such as commodities just like it did throughout the second half of 2010.

The Reuters Jeffries CRB index is down nearly four percent on the week with just a few markets showing gains either from safe haven flows or from weather related issues. 

Going for gold
The price of gold reached a new nominal high at USD 1,681 as safe haven flows continue to support the yellow metal. It was not however immune to the selling elsewhere. The accelerating sell off-in S&P 500 on Thursday led to a quick 40 dollar retracement in gold before recovering. Silver fared worse as the 35% sell off earlier this year has left investors much less inclined to hold on to positions for longer. On Thursday this resulted in a seven percent sell-off leaving silver in negative territory on the week.

Technically gold reached the top end of the channel in which it has confided since October 2008 and in the short term that could provide some resistance with support now seen at 1,630 followed by 1,600. 

Oil prices hurt by economic slowdown
The price of WTI crude dropped to the lowest level in eight months as the uptrend from the 2009 low got broken. Having lost more than one quarter from the May high it is now only some five dollars above the 2010 average at 80 dollars. Meanwhile, Brent crude found support below 105 for the third time this year with the spread to WTI holding firm above 20 dollars. 

A slowing U.S. economy and general risk adversity caused by the stock market sell-offs had investors scaling back long positions in anticipation of reduced demand for oil in the months ahead. It certainly looks as if consumers have been hurt more than expected by higher oil prices during the past six months and the International Energy Agency stands vindicated in its decision to pump strategic reserves into the system. Tight fundamentals however should continue to support prices and prevent a major sell-off from current levels despite the continued elevated level of speculative long positions that exists, especially in WTI crude

Grains: Modest corrections compared to other commodities
Temperatures across the U.S. have been seasonally higher than normal during the month of July. This has caused the quality of the crops to deteriorate, thereby keeping prices supported despite the general level of risk adversity caused by weaker economic growth. The price of December corn, which reflects the new crop, revisited the June highs. Only a change towards more crop friendly weather will prevent prices from moving higher still as a certain level of demand destruction is required to prevent expected tightness of stock in the months ahead.

The price of new crop soybeans has been trading sideways since December roughly in a 12.90 to 14.10 dollar per bushel range. The weather during August is more important for the development of the bean as it is planted later and has a different maturity cycle than corn. A continuation of dry hot weather could therefore add some upside pressure to this crop as well. For now though near-term weather forecasts suggest that rain and more normal temperatures will return during the next couple of weeks. On that basis the established range should prevail but look out for the production and supply/demand report from the United States Department of Agriculture due August 11.

Meanwhile, the price of wheat remains stuck at the lower end of its recent range as Russia has ramped up exports in order to regain the market share lost during the export ban that lasted until July 1. Russia may export 20 to 25 million tonnes of grain this season according to the Grain Union President thereby offsetting lower production in Germany and France. Dry spring weather has been replaced by wet August weather which literally has left combine harvesters stuck in the mud. Higher corn prices however will support wheat prices as this could force an increase in corn to wheat feed substitution.

Base metals pricing in lower demand
Copper together with the other base metals fell to a five-week low after the biggest weekly drop since March. The LME base metal index fell 5.5% while a basket of European basic resource companies lost more than twice that on concerns that a faltering global economy will curb demand in the months ahead. Not helping copper either were news that workers at the world’s largest copper mine, Escondida in Chile had accepted an improved offer and would return to work after a two week strike over bonuses and benefits.

Sugar: Speculative longs heading for the exit
Sugar suffered heavy losses this week on a combination of expectations for a sharp increase in Northern Hemisphere production and lack of any supportive news from Brazil. Reduced production in Brazil, the world’s largest producer, helped the price of sugar reach a high of 31.68 cents per pound back in July before succumbing to profit taking. Since late May the speculative long position in sugar has risen strongly and this is now causing long liquidation at a time where trade houses have been reported as sellers as well.

Back into Commodities, especially Gold and Grains

Funds and large investors have begun to move back into commodities, especially gold and grains. According to the weekly data from the Commodity Futures Trading Commission, released last Friday with data from July 12, total speculative investments in U.S. based commodity futures (ex. options) rose by 13 percent to 1.111 million lots or 92 billion dollars in nominal terms. This was the biggest weekly rise since August 2010.

Increases were seen across all five sectors with the biggest percentage change being meats, while the biggest nominal change was metals.

Gold positions rose by 25 percent to 197,600 lots as the ongoing debt crisis in Europe triggered a new record high thereby attracting investors back to the yellow metal. This was the biggest surge in holdings since September 2009. Copper also saw a 25 percent increase as recent high prices and the outlook for future demand looks supportive.

Crude oil also saw renewed interest as traders began to believe that the International Energy Agency induced sell off would not stick with focus once again switching to the potential for future demand outstripping supply.  The net speculative change on the week for WTI however was flat as an increase on Nymex was offset by a reduction on the ICE exchange.

Long positions in the grain sector recovered strongly with the soybean sector seeing most of the increase. With attention now firmly back on fundamentals, after the recent bout of risk reduction, investors have returned as hot weather in the U.S. has increased the risk of lower output.

Sugar continued to receive interest from the fund community as the strong rally back to the 30 level saw speculative long positions increase by 5 percent last week.

Investors in Lean Hogs who initially had been caught out during the recent strong rally tripled their long positions last week to 14,000 lots, still well below the 40,000 lots that was recorded when the price hit these levels last time back in April.

Background information: The Commitments of Traders is a report issued by the Commodity Futures Trading Commission every Friday with data from the previous Tuesday. It comprises the holdings of participants in various U.S. futures markets split into "commercial" and "non commercial" holdings. The non commercial or speculative holding are typically institutional investors such as hedge funds and CTAs.

 

Did Copper Just Give The All Clear Sign?

By Jonathan Chen
Benzinga Staff Writer

Copper has been on a nice uptrend recently, and it recently just broke out on the daily chart.

Copper is so important because it is used in everything, from housing to industry to automobiles to electronics. Hence why economists have given it the nickname, “Dr. Copper.” Excluding earlier this year, copper is the highest it’s been in years, and it looks poised to break the $4.50 per pound mark, which can potentially lead to $5 copper, something we have never seen.

As such, the related equities and ETFs are moving with it. Names like Freeport-McMoRan Copper & Gold (NYSE: FCX), and the iPath Dow Jones-UBS Copper Subindex Total Return ETN (NYSE: JJC [FREE Stock Trend Analysis]) are both sharply higher today, up 4.5% and 2.5%, respectively.

Freeport is generally the most common barometer of copper and industrial use amongst commodity related equities, as the company is the world’s largest seller of copper.

With shares trade at under 9 times forward earnings, and sporting a 1.9% dividend yield at these levels, it looks as if copper, and thus, Freeport-McMoRan Copper & Gold is not overvalued by any stretch of the word.

The company trades at 0.7 times earnings growth, although miners tend to trade below market multiples, as analysts are generally skeptical of the commodity bull cycle, and have been for some years.

Read more

From the Wild Wild West to tranquility territory

Clearly most short-term speculative accounts have reduced positions dramatically, as also seen in ETF net-long positions, whilst long-term investors have stayed put, and are possibly first watching Wimbledon and now the Tour de France, with no intention to escalate positions.

Still, they may choose to stay alert like Annie and keep some powder dry for flash crashes, dips and stop related sell-offs as the secular trend for commodities remains intact.

Risk-off in June reduced investor net-length significantly, back below 2008/2009 and 2010 highs despite underlying demand being intact and weather disruption supportive factors.

Source: Morgan Stanley analysis

Oil prices floored
Oil prices found the floor after the International Energy Agency hiccup. Again, as shown in CFTC data, speculative accounts have reduced net longs in WTI and Brent and most major top five banks which were premature in hiking oil price outlooks have now revised outlooks down by $10, still eyeing WTI $110 and Brent $125.
The IEA 60 mln barrel release seems to be oversubscribed, already indicating firm underlying demand clockwise from Sapporo to Vladivostok, so the impact of the emergency stock release on the global balance is likely to be relatively short-lived and long-term bullish.
IEA inventory release showed yet another draw higher than expected and boosted by positive U.S. economic data releases, WTI finished this week at the highs of 98,60 from last Fridays 94,50 whilst underlying fundamentals remain bullish for oil as we are living with no spare capacity.

Source: Bloomberg

Natural Gas traders akin with US weather prophet
You really have to be a U.S. weather prophet to week trade natural gas to determine if air conditioning is on and off with no correlation with Dow Jones. U.S. natural gas futures slid more than four percent lthis week, pressured by weaker cash gas and improved nuclear generation despite some ongoing heat. Inventory data caused another day tumble to lows of $4.13 MMBtu. The IEA storage report showed 95 Bcf injection much higher than expected and with the deficit set to evaporate before summer ends, the outlook for gas is looking increasingly bearish.

Precious metals – Hype is behind us
When my Mum and cab driver do not mention silver and gold for three weeks, then I know the Q1 hype and price rally is behind us. Also ETP silver product flow shows the smallest net long positions in three months and with a clear indication that speculative accounts are not willing to take gold prices higher than1550 - with producer hedging obvious and break-even prices for cost of production putting a firm bottom under the market around 1200 ex profits - then around 1400 seems to be the absolute floor currently from a demand/supply perspective.
However good news from the global auto sales industry is keeping a floor under  platinum prices after the Japanese tsunami earthquake related soft patch trend. Gold wobbled back and forth this week on ratings issues and closed 3% up on the week.
With positions being fairly neutral, the next move will be fierce, so stay alert!

Agriculture – China steps in
Next week is busy again as USDA and WASDE report crop conditions, ending stocks and production and with U.S. weather changing by the minute all grain products are facing volatility going into next week.
This week however was recovery week followed by last week's dramatic limit down sell-offs in wheat and corn on the back of acreage and ending stocks data, with major news that China was stepping in buying corn for storage again.

Russian wheat sales continued to weigh on the market amid seasonal pressure from U.S. winter crop harvests and crop conditions for corn and beans are pretty good because the weather is helping the yields, so the market is currently capped on the upside too.
Corn prices rallied a good 4% after the wash out last week, boosted by sentiment, fresh Asian buying and higher oil and sugar prices, leading corn higher through ethanol demand

U.S. rice futures close solidly higher as India's agricultural minister switches course to say he will not push for grain exports. A continued ban on grain exports from India most likely means increased demand for rice from other countries and with India being the second-largest producer after China, but also consumer, it remains a key driver for rice prices when exports are regulated.

Source: Bloomberg 

No Cocoa please, but hot Coffee and plenty of Sugar

Coffee
Parts of Brazil's Minas Gerais coffee belt were mildly hit by frost this week and supported current prices. Frost can kill coffee trees' leaves and branches, reducing output in the following year's crop. Such freezes are rare but this is the worst since the last major freeze in 2000 occurred last week, but was mostly confined to minor producer Parana. Being the world's largest producer of Arabica coffee, Brazil remains the one and only coffee price factor with Vietnam producing Robusta  instead. All in all it’s all down to weather and frost in Brazil, so risk remains for higher Caffe Latte prices at your corner cafe.

Sweet Sugar up 10%
The queue of ships waiting to load sugar at Brazilian ports rose from 64 to 86 this week, as the world's largest sugarcane crop nears peak harvesting. Waiting times for ships to load were between 8 and 10 days, which would appear to be much shorter than a year ago when ships faced waits of a month or more at some congested ports when rain repeatedly interrupted loading.
UNICA revised down cane crush estimates and sugar took off to the moon and continued production fears in Brazil is keeping front prices firm and squeezed this week, whilst deferred contracts 2012 are still trading 20% lower than spot. Super low inventories, Brazilian harbour congestion and long speculative longs are keeping front prices sweet as well.

Cocoa, O’Boy
The cocoa surplus for the 2010-11 season is likely to affect the market in the third quarter as shipments resume from top producer Ivory Coast, which produces 1/3 of world output.
Rains in the Ivory Coast's key cocoa growing regions last week were ample for the development of the mid-crop until late August and the Ivory Coast is now the end of the 2010/11 season with a bumper crop well ahead of target largely due to good rains. 

Cocoa purchases in the world's number two grower Ghana reached 940,000 tonnes by mid-June, putting output over 50 percent ahead of last year and the bumper harvest had strained storage facilities and led to some congestion at some port and depot facilities. 
Market prices have peaked and market direction looks bumpy with negative bias.

 

Copper, force majeur decouples C from C
Production at Collahuasi copper mine, the second-largest in the world has reportedly fallen to 30-40% of capacity over the past week due to on-going adverse winter weather conditions.
Indeed, current weather conditions were described as a once in "every 50 to 65 years" also as supply-disruption in Chile has come from the separate threat of a 24-hour strike by workers at Codelco, the world's biggest mining company. The final concern on the supply-side has come from Grasberg mine in Indonesia being the third-largest mine globally. The seven day strike at the mine has reportedly reduced the mine site to operating at close to 10% of capacity. So copper rallied for others reason than the Chinese rate hike which would otherwise put pressure on prices. So, Copper has decoupled from China gaining yet another 4 percent this week on top of last week’s rally. The trend is your friend, so be it.

 Source: Bloomberg

By Kjeld Lynggaard, Senior Manager, Trading Advisory on behalf of Ole Hansen.

Why all short-term traders should always watch copper

How many times have we heard about Dr. Copper as a great “tell” for the economy?   It’s on the radar for most longer-term traders but it should also be on the radar for short-term traders.    We’ve said it a hundred times to our subscribers over the years that copper is THE tell on our market screen.   It often leads the market up and down.   Today was a fantastic example as it bottomed at 11:30 bar while the SPX kept falling for another 18 minutes until it bottomed.

Take a look at this overlay of SPY over HG_F

Should USDCAD be higher?

A little focus on the neglected USDCAD pair, which continues to bide its time below parity. Considering the sell-off in crude prices today and developments in interest rates, should the pair be trading much higher? Today we have a look.

Oil prices are not oil prices
Before we discuss USDCAD versus oil prices, we have to realize that everything depends on which oil prices we are talking about. Canada exports much of its oil to the US, where prices are based off the WTI benchmark, one that is highly dependent on the inventory levels at Cushing, Oklahoma. With an absolute glut there, the price of WTI has been in a virtual freefall for the last week or more. Much of the rest of the world uses prices based on other benchmarks – like North Sea Brent, one of the better known alternative benchmarks. While . This is extraordinary, as Brent is an inferior grade of oil that normally trades for a slight discount to higher crude grades like WTI. Today, in fact, the spread between the two grades was a record 11 dollars a barrel.

Below we  have a look at USDCAD (inverse) versus WTI crude, which suggests that the pressure should be to the downside on the Loonie relative to the greenback.

 Against Brent, the picture is less clear and it would be helpful for USDCAD upside if world oil markets were a bit more in synch as it is easy to argue that the local supply glut in the US is a temporary thing. It is worth noting that today, Brent saw a rather steep sell-off after trading at a new high for the recent cycle.

Interest rate spreads and other factors.
Here, we see more convincing evidence that the pressure is on the CAD to depreciate if we use a measure like the 2-year interest rate spreads, which are much tighter than they were trading two weeks ago, when they were at the widest for the cycle.

Chart: USDCAD vs. 2-year rate spread

As for central bank guidance, while we know that the Fed seems on permanent hold forever, the Bank of Canada is loathe to touch interest rates with the CAD at such strong levels and with its terms of trade heading sharply in the wrong direction over the last couple of years (to an outright trade deficit.) Just today, the BoC’s Carney was out saying that he is comfortable keeping rates at recent low despite food inflation globally and that the “thing that keeps him up at night is that in this rebalancing of global demand, the Canadian current account has swung 6 percentage points of GDP in the last three years, from a 2% surplus to a 4% deficit.” It doesn’t look like we should be pricing in any rate hikes just yet.

As for “other factors”, we can mention relative sovereign debt worries and risk appetite as other relevant factors in this market. In the sovereign debt department, it is understandable that the market has a hard time bidding up the USD when the US has shown so little credibility on the austerity front and continues to show a stark fiscal picture. In the meantime, Canada is considered one of the most fiscally solid countries in the world (partly a mirage because of a vastly leveraged consumer sector, but still the case).  Finally, risk appetite remains very robust at present, and this tends to favor a more pro-cyclical currency like CAD over the USD.

Long story short – by a couple of measures (interest rate spread and WTI oil prices), USDCAD looks underpriced, but we would like to see an expansion in risk aversion and a more pronounced sell-off in non-WTI oil and other pro-cyclical commodities like copper if we are to see USDCAD rally again above and beyond the parity level.

Another story: AUDCAD
On the pro-cyclical commodity front, it is interesting to note the AUDCAD pair, which we plot here relative to the copper/Brent crude oil ratio. Aussie has been in trouble a bit lately, but risk appetite and copper have kept it from a steeper drop. Either of these legs being removed could trigger a tumble in the Aussie – even against CAD, as we suspect the potential downside for copper is larger than for crude. While copper is strong on physical buying related to warehousing and financialization, crude will never be financialized the same way and we wonder how long the copper bubble can continue before it pops (and if all of the commodity price rises are about distrust in fiat currencies, then crude oil should more than keep pace with the red metal.)

Chart: AUDCAD versus copper/oil ratio

FX Closing Note: USD/Risk divergence and more

The USD sharply weaker today as risk and commodities go ballistic, but there are signs that some divergences relative to past behavior may be developing here. Also – we look at AUDUSD and USDJPY technicals today.

USD, risk and Interest rate spreads
We pointed out yesterday that risk measures had been coming off heavily as the USD was rallying. Over the last two days, however, we have seen an epic bounce in risk and a fairly strong sell-off in the USD, so we’re not having much success in finding the leading indicator here in this rather closely correlated market. We do find it interesting that US equity indices are trading at their two-year highs while many of the USD crosses are showing the greenback is still relatively far off its recent lows.  This may be a sign that there is enough belief in some of the stronger numbers coming out of the US at the moment that people are deciding that the US economy isn’t looking so bad relative to other economies and that the Fed might even be sidelined by the strength – in the most extreme instance possibly not even needing to complete the QE2 program. Not our belief – but the market’s. Some proof of this can be found in the interest rate spreads, which still show reasonable support for the USD. Does this mean that we are seeing some weakening of the USD/risk bond? Maybe - the strength of the correlations seems to be a bit weaker in any case due to the introduction of relative US economic reslience.

Interest rate spreads generally USD supportive, but…
The chart below shows that the pressure is still on NZD to fall versus the USD if we are only using interest rate spreads as our guide. USDCHF should be trading at a new high by the same token, but the market isn’t interested at the moment. Let’s see where we are on the spreads and on the FX charts after the close tomorrow.

 Elsewhere, while spreads aren’t particularly supportive of the USD selling off against the AUD and CAD at present, very strong commodity rallies in copper and oil and other parts of the commodity complex mean a struggle to weigh which factors are most important, with commodities clearly winning out at the moment. Below we show AUDUSD vs. the price of copper.

 Technical highlight - USDJPY
Bonds tried to rally and throw the JPY a rope as well, as USDJPY retreated from resistance areas and other JPY crosses found resistance to varying degrees today as well. Later, most of the bond supported eroded as the colossal rally in risk instruments continued elsewhere. Note the importance, once again, of the Ichimoku cloud level for USDJPY - this time it is the upper cloud that is serving as support. Those looking for a continuation of the sell-off will need to this first important support give way (currently around 83.20). To the upside we have the psychological 85.00 area and then the 200-day moving average currently around 83.70.

 Technical highlight – AUDUSD
AUDUSD has rallied very sharply, back above the key flat-line levels that formerly served as support in the 0.9650–0.9700 area. The important resistance levels now are the 55-day moving average around 0.9800, the falling line of consolidation and the 0.618 Fibo retracement for the entire down-move up around 0.9935

 Weekly AUDUSD Chart
On the weekly, the rising trendline has even more strategic importance here, now that we have seen the third touch of the line at the low of the recent sell-off. Generally, a trend-line is far more interesting once three touches are in place, as they are an order of magnitude more rare than the pedestrian two-toucher.

 Topic: US jobless benefits linked to Bush tax cut deal?
It appears that the Republicans are trying a gambit in which any deal on the extension of jobless benefits (which they oppose because there are no announced cuts elsewhere in the budget to pay for them) might be linked to a deal to extend the Bush era tax cuts beyond the end of this year. If no deal is reached on benefits, the US Labor department says that 600,000 will lose their benefits immediately and another 2 million would lose them at the end of this year. 

FX Update: Tomorrow not just another day?

Yesterday's pull off the lows in risk appetite saw a bit of follow through overnight, but that move is  retreating a bit as market is afraid to commit directionally ahead of the Bernanke speech tomorrow.

Technical tea leaves

The market continues to trade nervously ahead of tomorrow's main event (the Bernanke speech), as yesterday's "breaks" saw now follow through and proved to be head-fakes so far. AUDUSD dipped to a new low but pulled back to just above the 0.8850/60 area in this morning's trade. Likewise, NZDUSD's deep cut below 0.7000 was erased overnight. Then this morning, the reversal itself was reversed as EURUSD tickled a marginal new high above 1.2720 before diving back into the range and JPY crosses were back lower as yesterday's bond rout saw a significant consolidation heading into this morning. This kind of action suggests a lack of willingness to commit and we should be cautious in reading the technical tea leaves until tomorrow's Bernanke event is behind us.

AUD

The Aussie got a bit of support from the recovery in risk from yesterday's lows and the rejection of the technical break lower in AUDUSD, but interest rate spreads have hardly budged and don't suggest that the Aussie should switch to rally mode here. We had a very disappointing Q2 capital spending data point out overnight that suggests Australia companies are heavily reducing their capital investments. On that front, it is clear that the only sector that can keep the Australia economy humming is the mining sector, which has been its champion industry for years now, but could also prove its Achilles heel. It is clear that following copper and other key Australian commodities will be critical for understanding the currency's trajectory going forward. On that account, the mining sector was a huge positive contributor to the capital expenditure data, so the overall number ex-mining would have shown an even steeper decline. And spending expectations from the mining industry are still very robust for the year forward.

Chart: AUDUSD and copper

These two instruments are joined at the hip. Copper is often considered a barometer on economic growth, as it the Aussie. The trajectory for both of these will be determined by China, which is the main destination of Australian copper and other exports and which has supported the Australian economy with its imports of thermal coal for steel-making and other key ores that end up in China's endless construction and infrastructure buildout. The question is when too much overcapacity in an economy is too much? When that point is discovered and the implications are pondered, AUDUSD is more likely to be trading close to 0.70 rather than 0.90. Until then, let's all enjoy the ride.

US claims data
The Weekly Claims data saw a sharp drop this week from yesterday's big move to 500k (now revised to 504k). As we have said many times recently, we have to take claims data at this time of year with a considerable grain of salt due to the seasonal adjustments, which are particularly large at this time of the year when firings are at their lowest rate of the year. We'll have a better idea of the claims trend as we head into October than we do now. Still, the number is the lowest reading in four weeks, so the market might draw a bit of hope from it ahead of next Friday's employment report. The bond market has decided to react strongly to the data in the immediate after math and this saw some pop in the JPY crosses, but any reaction is likely to be short-lived considering the volatility of any weekly data series and the far more important event risks on the horizon like tomorrow's Fed speech and next week's raft of important numbers.

Looking ahead
The market will likely continue to trade nervously ahead of tomorrow's speech. Again, the key here is to what degree the market is investing its hope in QE2 and to what degree Mr. Bernanke will deliver. If hopes are high for QE, we suspect that Mr. Bernanke will disappoint, which would have the usual results in FX - negative for pro-risk commodity currencies and positive for the USD. The question, as we suggested in yesterday's closing note, is whether a QE2 disappointment would see a bond consolidation, which could finally mean the USD getting out from under the Yen's thumb if we get both risk aversion and a treasury sell-off - perhaps the most interesting scenario.

Economic Data Highlights

• Australia Q2 Private Capital Expenditure fell -4.0% QoQ vs. +2.3% expected
• Germany Sep. GfK Consumer Confidence out at 4.1 vs. 4.0 expected and 4.0 in Aug.
• Switzerland Q2 Employment Level rose +0.6% vs. +0.8% expected
• Sweden Jul. Trade Balance out at 10.3B vs. 6.5B expected and 9.7B in Jun.
• Sweden Jul. PPI out a +0.1% MoM and +1.0% YoY vs. +0.3%/+1.2% expected, respectively
• Sweden Jul. Unemployment Rate out at 8.0% vs. 7.9% expected and 9.5% in Jun.
• Sweden Jul. Household Lending rose 8.8% YoY vs. 8.9% in Jun.
• UK Aug. CBI Reported Sales out at 35 vs. 18 expected and 33 in Jul.
• US Weekly Initial Jobless Claims out at 473k vs. 490k expected and 504k last week
• US Weekly Continuing Claims out at 4456k vs. 4495k expected and 4518k last week

Upcoming Economic Calendar Highlights

• US Mortgage Delinquencies (1400)
• US MBA Mortgage Foreclosures (1400)
• Japan Jul. Jobless Rate (2330)
• Japan Jul. Overall Household Spending (2330)
• Japan Jul. National CPI (2330)

Weekly Fundamentals - Energy Prices Tumbled amid Intensified Concerns on Slowdown

Trading was relative light in the commodity sector as investors continued to gauge the implications of macroeconomic indicators and government officials' comment on global economic outlook. Despite broad-based decline in risk assets, the dataflow was not entirely poor last week. US' industrial production rose +1% m/m in July after contracting -0.1% a month ago while UK's retail sales and net borrowing showed signs of improvement. Unfortunately, the market only focused on the weak side of the economy and reacted vigorously when US initial jobless claims surprisingly rose to 500K in the week ended August 14 from an upwardly revised 488K in the prior week and ECB member Axel Weber signaled stimulus should stay for the rest of the year. 

Read full article here

WE'RE GETTING CLOSE TO THE DANGER ZONE - Brian Hunt's Market Notes

An update on last week's claim that it's "amazing what several trillion dollars will do to goose an economy."

It is not just amazing... It is truly, absolutely stunning what several trillion dollars will do to goose an economy. For proof, have an updated look at our frequent guest, copper.

As we mentioned last week, governments around the world are injecting huge amounts of money and credit into the struggling patient known as the global economy. All this Monopoly money is driving rallies in stocks and bonds. It's also driving a stunning rise in copper... the major building block of cars, refrigerators, power lines, computers, and houses. The metal is up 97% from its February low... and up 27% in just the past month.

Any sane person must be worried about all of this "funny money" debasing their paper currency... which will push up the nominal price of commodities like copper. Again, we encourage everyone to keep an eye on the $3-per-pound area. It is around this point that the market is saying, "looks like we have a dollar problem on our hands."