20 January 2012 at 14:15 GMT
Global stock markets have seen one of the strongest beginnings to a new year for decades and the doom and gloom that persisted during parts of 2011 has at least temporarily been put aside. Cash rich money managers, many of whom opted for defensive and conservative strategies at the beginning of the year, are behind the curve and have been chasing the market higher as focus has shifted away from the problems in Europe to supportive economic news from China and the U.S.
Commodities in general have not joined the party in the same way. The energy-heavy S&P GSCI is showing a healthy return of 2 percent for the month while the more broad-based DJ-UBS index has so far only mustered 0.3 percent with strong gains in metals being weighed down by losses in the grains sector. Some of these gains have been eroded by the weaker dollar which ran into profit-taking after speculators built up near record long positions, especially against the Euro.
Gold rally fading despite weaker dollar
After a 160 dollar move up from the December low, gold paused for breath this week, rising by less than what the dollar dropped. The strength in stock markets have sapped gold of some its allure as an alternative investment. The Chinese market will effectively be shut for the next couple of weeks in celebration of Lunar New Year so trading will cease and demand should ease. On that basis we suspect gold could be in for a bumpy ride over the coming week, given the potential for the dollar to strengthen again after its recent correction.
ETF investors also seem to be adopting a wait-and-see approach. The net flow into the major ETFs, despite the 160 dollar rally, has been slightly negative since the beginning of the year. The same goes for speculative investors through futures, where the net position has only seen a slight increase, indicating that hedge funds at this stage are looking towards other commodities for exposure.
Technically gold has found resistance at 1,670, the bottom of the previous trading range and trend-line from the September highs, while the 200-day moving average at 1,642 provides support before 1,600.
Oil lower as supply disruptions fears easing
Oil prices have moved to a sideways wait and see pattern as concerns about supply disruptions have eased somewhat. In Nigeria oil unions reached an agreement and Iran hinted that it was ready to resume talks with western nations. Earlier in the week oil prices got a temporary boost on news that Saudi Arabia was aiming to keep oil prices at around 100 dollar a barrel, some 25 dollars above their previous official stated target from 2008. According to the IMF higher social spending in the Kingdom has raised the price needed to balance its budget to 80 dollars, up from just 50 dollars in 2008.
According to the International Energy Agency, oil demand during the final quarter of 2011 has fallen for the first time since the financial crisis of 2008 and 2009. The reasons behind the change were weakening economies, a mild winter across the northern hemisphere and not least high crude oil prices. Although the current price of Brent crude is comfortably below the highs of 2008, a different picture is emerging when looking at prices in other currencies, and this helps explains the negative impact on economic growth currently experienced. Below chart shows the relative price development of Brent in different currencies measured from the record close price on July 3 2008.
Natural Gas heads towards the abyss?
The month-long sell off in natural gas, which stepped up a gear once 3 dollar gave way earlier this month, is down 23 percent in 2012 and 13 percent this past week alone. The fall to a decade low has been caused by high production as shale rock drilling booms and an extraordinary mild winter has led to a record build of supplies. This could bring about a situation with limited storage which could force down the price even further. The market is now extremely oversold and speculators are short raising the risk of a near term bounce should we see a shift in weather forecasts.
Industrial metals reborn
The sector that suffered the most in 2011 has returned with a vengeance. The defensive approach to cyclical commodities at the beginning of the year has backfired, as the outlook for Chinese and U.S. growth have improved and the situation in Europe not gotten any worse. Adding to the rally has also been raised hopes that China will soon ease monetary policy.
To explain the strong rally in copper, you only have to look at how speculators have been positioned. As of last week, they held only net short positions in 7 out of 24 major U.S. traded commodities - and copper was one of them. This has helped trigger a strong short-covering rally in copper and other metals, with the LMEX composite metals index being up 10 percent in January.
Copper has now retraced back to September 2011 levels, which now raises questions about the sustainability of this rally, especially after having retraced half of the 2011 move down. The most recent reading on Chinese PMI still points towards contraction, so while a soft landing in China is now expected the question remains whether it will be enough to support metal prices at these higher levels.
Near month High Grade copper - Source: Bloomberg