CO:Commodities stage decent recovery, gold still attractive
There has been a decent recovery in commodities after the EU proposal. Something good came out after a long period of negotiation and talks. The EU deal done on 26th October though did not look like a Silver bullet, but market rallied on positive news breaking the chain of bad news. Rating agencies were behind the PIIGS nations like a ghost. Their comments and continuous rating cut had been fueling their sovereign borrowing cost. The fear of imminent banking crisis in the EU area is fading now, as many feared the default of Greece debt could have Lead to a liquidity crunch.
The rescue package unveiled by euro-zone leaders last week was heralded by the markets as a significant step forward in addressing the European Union’s (EU’s) sovereign debt crisis. After all, the package included bold measures to reduce Greek debt, strengthen the banking sector and top up the coffers of the European Financial Stability Facility (EFSF) at least in theory. The complex agreement will buy the euro zone only a temporary reprieve. In the long run, the survival of the single currency requires addressing the fundamental problems that are undermining the euro zone.
The deal has bought some time to cool the market. Yes, all markets rallied, Euro rose almost 1000m pips v/s the US dollar from its October low, the UK FTSE index rose, the DAX rose and commodities such as Oil, Copper, Nickel, Lead and Aluminium rose. The bullion also recovered with Spot Gold rose to $1750 an ounce from Sep low of $1532. Silver rose to $35 from $26.02m posted in September.
Commodities which are directly linked with global growth had the immediate impact. The EU driven sell off was mostly in the nature of fear of banking crisis which could have lead to a tight credit and hence jeopardize the EU economy. Apart from that slowing down of China, Euro zone and US was a concern.
Another positive news attracted the market attention- a better than expected US GDP number. The world's biggest economy grew at a 2.5% annual pace in the July-September period, the best in a year, led by consumers and businesses. Wall Street expected a 2.3% rate after Q2's anemic 1.3% and Q1's 0.4%. U.S. GDP, the sum of all goods and services produced, was $13.35 trillion in Q3, finally surpassing its pre-recession peak at the end of 2007.Consumer spending, which accounts for 70% of economic activity, rose at a 2.4% rate in Q3, well above Q2's 0.7% pace despite plunging confidence. Business investment rose at a robust 16.3% clip, the fastest in more than a year, on higher outlays for equipment and software. Government spending was flat due to state and local budget cuts.
These two events have some positive attributes to the market. However, the outlook for the global economy has not changed drastically positive. The major concern for the commodities front is the slowing Chinese economy who is the major and leading consumer of industrial metals.
Chinese metals companies are warning that Beijing’s monetary tightening has gone too far, causing domestic customers to delay orders and raising the risk of payment default. In one of the clearest signs yet of deteriorating sentiment, Baosteel, China’s second-largest Steel producer, has told the Financial Times that its customers were pushing back scheduled deliveries “due to declining economic growth and tightening credit”. China buys such a large share of global commodities production that even small changes in demand have an oversized impact.
The supply side problem may support prices. Nickel, Zinc, Aluminium prices are trading near their marginal cost of production. E.g at a price of $2000 almost 25-30% of aluminium producers are expected to be losing money. Zinc at $1750 per tones - high cost producers from Japan may lose money. Crude Oil which is highly used in metals industry has been at higher levels. Apart from that wage cost for producers has not declined, rose instead. There has not been a decline in production cost while prices are falling now. This may Lead to a rebalancing trend in the market and may see supply cut in near future if lower prices persist.
In case of Copper, prices are still double than the costs of production, but supply threats are not allowing prices to correct. Though supply fear persists, a decline in demand from China may lead to a selling pressure in the Copper market which has eased currently due to optimistic EU deal.
In energies, drop in oil prices have halted and NYMEX WTI rose over $20 from its low. The Brent is still at the triple digit figure. A major decline in Oil prices is not imminent due to supply cut. One of the major factors that are supporting the market is the ongoing loss of Libyan oil production. Oil production is not going to normalize anytime soon and that it could take as long as a year before we see normalization of that production. The country contributed almost 2 % of global oil consumption before war. Libyan Officials had expected output to reach about 500,000 barrels per day by the end of the year and to achieve prewar levels by the end of 2012. There is expected to have a slower growth of demand in Crude oil and it will not allow prices to sustain stable above the $100 a barrel
In bullion, Gold will remain attractive as long term investors. It is currently around $1720 an ounce and expected to see buying interest from both official and retail sector. Silver which is mostly used as an industrial metal may not see strong recovery as global industrial sector is cooling. We maintain our view of $25 an ounce in Silver in the medium term. However, a short term rally cannot be ruled out due to recent optimism from US and Europe.
