COM: Commodities gain as central banks lower rates
Financial markets including commodities reacted positively to what looked like concerted efforts by central banks to boost liquidity and confidence. Five major central banks announced a coordinated reduction in the interest rate charged on US dollar swaps, which should help the flow of liquidity between international banks and The People’s Bank of China surprisingly cut the reserve requirement ratio for domestic banks, as its manufacturing activity contracted for the first time in almost three years. This has forced it to shift focus back towards growth as the world’s second largest economy looks set to slow down much faster than expected over the coming months.
The CRB only lost 0.4 percent during November and is down 5.6 percent year to date. During the month the debt crisis continued unchecked with the dollar rising by 1.4 percent against a basket of currencies and thereby removing some support for commodities. The star was WTI crude which closed some of the gap to Brent and generally stayed supported on the back of tightness ahead of winter and geo-political risk looming in Iran. Agricultural commodities fared the worst with seven out of the bottom ten belonging to this sector.
The price of Copper jumped strongly from an oversold situation and most other commodities followed, not least helped by what looked like temporary weakness of the dollar. Meanwhile the US economy continues to decouple from the rest as economic data continues to surprise on the upside further removing the risk of recession in the world’s largest economy. The recession in Europe and slowing developing economies however will probably not avert the global economy from slowing further during the next 3 to 6 months and commodities will be struggling to move much higher on that assumption.
It is important to note that this is not a turning point for the Eurozone debt crisis and politicians needs to show a similar resolve as the central banks as the sovereign debt crisis in Europe requires much stronger medicine and only they can deliver the potential cure, whatever that may be. Difficult market and trading conditions therefore look set to persist for now with the length of elevated volatility now only having been exceeded by two periods during the 1930’s.
Headline risks persist ahead of year-end
The central bank actions triggered a major stock market rally but the bond markets failed to buy into the relief with especially Italian bond yields staying at elevated and long term unsustainable levels while the return on German one-year government bonds has fallen below zero with many investors now more concerned about the return of, instead of a return on, their money. With liquidity continuing to dwindle as we head towards year-end the markets will become more and more driven by headlines and very short-term trading decisions as traders try to protect whatever profits they have or limit their losses.
Speculative long position cut to the lowest since July 2009
Hedge funds and other large speculators continued to reduce exposure to commodities during November. The recent data from the Commodity Futures Trading Commission showed that they have reduced their combined long exposure of futures and options on the 25 commodities we track by 19 percent to 770,000 lots, the lowest level since July 2009 and well below the recent peak of nearly 2 million contracts back in February. In nominal terms the exposure dropped by $12 billion to $76 billion last week.
This data is becoming increasingly important to keep an eye on as a potential reverse indicator. A good example of this was Copper this week which saw an intraday low to high swing of 10 percent. According to the CFTC investors had tripled their short positions in copper as the outlook continued to deteriorate. This left it vulnerable to positive news and this was what the Central Banks delivered and a strong rally followed as short positions were scaled back.
Pent-up demand triggers Gold rush
Gold traders reacted strongly to the central banks’ announcement after having been trading quietly over the last week. The move up to 1,750, the highest in two weeks, was supported by heavy trading volumes and could indicate that while many have been looking for a larger correction they do not want to miss out on a potential move to the upside. Gold is generally being viewed as one of the safest and most defensive investments among commodities while the economic outlook deteriorates. We believe the dollar will soon find support and strengthen again and this remains a major deterrent for the price of gold to rise unless the crisis escalates even further.
Crude oil stuck between two chairs
The price of oil went looking for resistance this week after important support levels at 95 on WTI and 105 on Brent crude held early on. The market is currently stuck between the deteriorating outlook for economic growth combined with the return of Libyan oil and winter tightness and geo-political risk. The clash between western government and Iran, OPEC’s second biggest producer, continues with the UK closing its embassy following an attack. This geo-political risk premium on oil, which could be worth five dollars on the price, will remain and could potentially widen further. Given the lack of firm convictions as to the future direction the established ranges, which are 95 to 105 on WTI and 105 to 115 on Brent, look set to hold.
Grain markets caught in a physiological down spiral
The grain sector tumbled the most with long exposure to corn, the up until now darling of the grain markets, dropping by 22 percent. The overall long exposure to CBOT grains now sits at only 69,500 contracts, down from 800,000 contracts in February when worries about this year's crop reached boiling point. The short position in the soy complex, which comprises soybeans, soy meal and soy oil, grew for the second week reaching -45,000 contracts.
The sharp reduction in investor participations over the last couple of months has been triggered by higher than expected production this summer while US produced grain prices have come under pressure as the strengthening dollar has sapped its competitiveness on the global market. The price of Corn and soybeans especially should remain supported as higher feed demand and Chinese restocking will ensure good demand in the months ahead. The global supply response to the higher prices over the last couple of years should also ensure a high amount of planting next year but with La Nina, the weather phenomenon, expected to make a return the outlook could easily change.
