Gold's safe haven status hurt again after Bernanke-inspired yo-yo

Commodity markets spent the week trying to recover from their dismal performances during May. What helped them along initially was renewed speculation about additional stimulus being provided by the US Federal Reserve following the weak employment report on June 1. Gold jumped the most in years only to tumble the most in two months after the Fed chairman in a testimony in Washington refrained from outlining any additional measures. 

China lowered its key interest rate for the first time in four years in order to stimulate a weakening economy, but again this failed to ignite the market as it raised speculation that upcoming economic data could be weaker-than-expected. Spain, despite managing to issue EUR 2 billion of debt, saw its credit rating drop by three notches as the banking and funding crisis continues. Attention over the coming week will return to Greece ahead of the June 17 election, with the result potentially triggering further speculation about Greece’s future within the Eurozone. 

Against this backdrop, riskier and growth-dependent assets like commodities will probably continue struggling until we begin to receive some answers to questions regarding the near-term prospects for global growth. Adverse weather, as witnessed recently, could once again be the only factor that drives individual (agricultural) commodities higher.

Strong week for agriculture while energy suffers

The agriculture sectors were the best performing last week with the DJ-UBS agriculture index returning more than four percent while precious metals index lost two and the energy index lost one percent. In the top six of individual commodity performances, we find the three major crops, which were all supported by either strong exports or dry weather across the key growing regions, both in the US and Russia. 

At the time of writing the more diversified DJ-UBS Commodity Index was on track to record its first, albeit small, weekly gain in three weeks, while the much more energy-heavy S&P GSCI index was on track to record its sixth week of losses, the longest weekly losing streak in 11 years. It highlights the aggressiveness of the sell-off, especially in crude oil, witnessed since early May. 

Gold caught in stimulus roller-coaster

The weak US employment report on June 1 once again raised the prospect of additional US stimulus and gold rallied five percent, moving back above previous resistance at 1,610. Having passed this hurdle, a few days was spent consolidating the gains, reaching 1,640 in the process, only to succumb to heavy selling by hedge funds following the noncommittal testimony from the US Fed chairman Bernanke on Thursday. The fact that the leverage community offloaded their long positions so quickly is a worrying sign as it shows the limited patience they have when it comes to holding onto positions in this volatile environment. 

This has once again blown a hole in gold’s credentials as a safe-haven, and attention will once again turn to outside markets, with the dollar once again having the potential for being the main driver in the short term. Although additional stimulus has not been ruled out, the Fed’s window to manoeuvre is getting shorter as no major initiatives are expected to be announced during the final months of the US presidential election campaign. 

We maintain our overall positive outlook for gold, given the unresolved Eurozone crisis, the continued chance of additional stimulus from the US, Europe or both, combined with negative real yields, which removes the opportunity cost of holding gold. But for now the exercise of rebuilding confidence commences once again, with the low 1,500’s providing the line that needs to hold in order to avoid further losses.  

Oil rally proves short-lived

The economic slowdown witnessed among the world’s three major oil consumers - US, China and Europe - proved too much for any further advance of crude oil this week. Following a few days of recovery from a much oversold situation, sellers returned and traders who had bought Brent crude futures on the move back above 100 quickly headed for the exit once that level gave way again. 

Brent crude is currently down almost nine percent in 2012 and trades well below last year’s average price of USD 111. Tight market conditions witnessed just a couple of months ago continue to ease on record Saudi Arabian production and rising North American production, combined with a slowdown in demand - especially in Europe. The additional cuts in Iranian exports once the US and EU sanctions begin on July 1 should therefore only shift the balance slightly and not have any major impact on prices. Iran could even be forced to discount its oil in order to find willing buyers, something that could add additional downside pressure on global benchmarks, such as Brent crude.

OPEC is meeting on June 14 and after the price collapse during May, some interesting discussions lie ahead, especially considering we have reached the level where Saudi Arabia feels comfortable. Will OPEC make an attempt to reduce supplies thereby stabilizing prices before the full impact of the Iranian sanctions is known and seasonally higher demand kicks in?  Or will they be worried about the current economic slowdown and opt to keep supplies at current levels, thereby risking an oversupply to the system? 

As mentioned in my last update, the technical outlook for Brent crude looks pretty grim, with a sustained move below its previous range - which lasted for 16 months - having caused technical traders to set their eyes on a 73 dollar target. For that to materialize, though, we would have to see further deterioration in demand from emerging economies and, most likely, a break-up of the euro. Geopolitical risks are constantly lurking, and with many oil producers requiring much higher prices now to balance their budgets than before the Arab Spring, a further drop would most likely trigger a response from producers. Ahead of the Greek election, however, traders will probably be on the defensive and a revisit to the recent lows at USD 95.60 on Brent and possibly beyond cannot be ruled out.

 A fall in world food prices offset by rising dollar

The monthly food price index, which comprises 55 different food commodities, had its biggest drop in more than two years in May. The the cost of dairy slumped, in particular, by almost 12 percent. The index, which is provided by the  United Nations Food and Agriculture Organisation, fell by 4.2 percent to index 203.9, a level not seen since October 2010, with the five different food groups all recording lower prices. Although it will bring relief to consumers, many countries who rely on imports and who pay in dollars will, however, not have felt much of an impact as the dollar strengthened by more than five percent against other major currencies during May.   

Overall, the trend towards lower prices has been in place for more than one year now, and comes on the back of high prices last year - which was met by a strong production response from farmers globally. The FAO also raised its grain production forecast for 2012-13 by two percent to 2.42 billion tons. Much of that increase relies on good growing conditions over the next couple of months, and as we have seen already, dry weather in central US and Russia continues to cause some concerns for wheat production, just like dry weather in South America earlier this year caused a sizable cut in the soybean production.