commodities update -
By Ole S Hansen -
Many investors have so far sold in May but whether they have gone away or are just waiting on the sideline remains to be seen.
Stock markets were very resilient during the first half of May despite the carnage in commodities. With important support levels however getting close to the near term there is additional risk reduction as inflation and lower growth begins to bite.
The Reuters Jeffries CRB index is down 1.8 per cent over the week and up just 1.6 per cent year to date. The sell-off has been broad-based with no sector avoiding being caught up. Fundamentally, investing in commodities still makes a lot of sense but once again we see the impact of what happens when too many want or need to exit a relatively small market in a hurry, compared to bonds and stocks which have much better liquidity.
The impact of the turmoil in commodities over the last couple of weeks was highlighted in the weekly Commitment of Traders report from the Commodity Futures Trading Commission. Hedge Funds and large investors scaled back futures positions across US commodities by 11 per cent last Tuesday to 1.359 million lots. This is the lowest level since August 2010 and has removed all the length that was added during the QE2 induced run-up in prices.
During the last six months the short dollar versus long commodity trade became increasingly popular. Some commodity markets like copper, sugar and rice actually peaked already back in February but once the correction hit crude oil in early May the whole sector got caught up in risk reduction.
Recent data shows that consumers have begun to react to the increased cost of living, especially the cost of energy, and this has shifted the focus from the unresolved supply issues, like Libya, to the demand side. The International Energy Agency last week warned that high crude oil prices had started to slow the growth in demand and it reduced its previous 2011 growth forecast to 1.5 per cent from 3.3 per cent previously.
Fundamentally, energy prices should find support fairly soon as supply growth outside Opec is slowing as well. This has forecasters looking at demand catching up with supply in the not too distant future and this will support prices once the current wave of risk aversion has run its cause.
Energy markets have so far seen two waves of selling over the last two weeks. What kicked off the latest was surprise news from the US Department of Energy that weekly gasoline inventories rose last week by 1.27 million barrels instead of falling as expected, for what would have been the twelfth consecutive weekly fall.
Gasoline had, up until now, been the driver of the rally and at one stage it came within five per cent of the high from 2008. Retail gasoline prices in the US recently reached an average of $3.98 per gallon, very close to the physiological level of 4 which undoubtedly would have increased political pressure for action.
The initial $21 sell-off in crude oil happened within 48 hours and left most analysts believing that it had removed enough of the speculative overhang to bring prices back up to previous levels. The gasoline driven second wave last week was not as severe as the first but it has left many potential buyers on the sideline waiting for a potential third wave of selling.
The first wave triggered a reduction in WTI crude speculative long positions by 20 per cent from the April peak to 243k lots. This is only a relative small reduction given the scale of the setback in price and could indicate that the selling has been met by fresh buying from traders who find sub-100 dollar on WTI attractive. The market is therefore still exposed to additional long liquidation as seen last week.
The extreme reversal that silver has experienced during these past couple of weeks has indirectly played into the hands of gold. Being the less volatile and better behaved bigger brother of the two, investors have increasingly been turning towards gold to hedge the various financial risks that still exist. While silver got caught up in a “tulip mania-style move” — both up and down — the correction in gold has been smaller than the previous three corrections.
The relative performance can be seen in the ratio between silver and gold where one ounce of gold a few weeks ago cost just 32 ounces of silver while this has now moved closer to 44 ounces. Considering the average over the last 10 years has been closer to 61 gold could have some more ground to make up.
Agricultural prices have been caught between risk reduction after a neutral to slightly bearish report from the US Department of Agriculture last week and support related to weather concerns during the ongoing planting season.
Wet weather in the US Midwest and dry weather in the south is currently delaying the planting of corn, wheat and soybeans and helping to support prices.
Some of the major base metals, apart from aluminium, peaked already back in February as a result of continued tightening of monetary policies in China, which the market believes could reduce demand from the world’s largest consumer.
(The author is Saxo Bank’s Senior Manager for CFD and Listed Products)