06 April 2011 at 12:44 GMT
Investors have had to deal with an unusual number of shocks during the first quarter of 2011. What began with an almost unanimous belief that the global economy would shift up a gear in 2011, which in turn would trigger higher energy and base metal prices, has turned into a steeplechase with one obstacle following another.
The low interest rate environment that investors have been getting used to since the financial crisis in 2008, and particularly after the QE2 liquidity boost last autumn, is slowly drawing to a close. Now the European Central Bank is expected to make the first move during April. Whether the U.S. Federal Reserve opts for quantitative easing round three or makes a move to normalise its interest rate environment could have a major impact on non-interest bearing commodities, like precious metals, in the months ahead.
Among the first quarter obstacles were: geopolitical tensions in MENA (Middle East & North Africa) resulting in a potential oil price shock, food price inflation, the Japanese earthquake and concerns about the fiscal crisis in the Eurozone. These have all, in one way or another, led to a slight reduction in growth expectations for 2011. But for now we do not expect them to have a material impact on the overall outlook.
Gold and silver
Gold has lost some of its 2010 support with silver being the preferred metal. The latter has enjoyed the attention from industrial users and investors looking for a store of value or a hedge against inflation. On that basis, many rightly or wrongly, have come to the conclusion that no matter what happens, silver will continue to be in demand. During the past six months it has outperformed gold by more than 40%, despite ample supply from mining and scrap, with the bulls having their sights on the old record at 50 dollars an ounce from 1980. One should, however, not forget silver continues to be a high beta version of gold and as such the private investor can experience severe washouts which can make it hard to hold on to.
Against the backdrop of elevated uncertainties we expect silver and gold especially to continue to consolidate and perform well during the second quarter. Gold has the potential of reaching $1,500/oz while silver points towards $38/oz.
WTI and Brent Crude
During January the price of crude oil rallied with rising stock markets and increased demand forecasts but accelerated when unrest broke out in the MENA region. The tensions resulted in Libyan oil exports being halted and raised fears about contagion to the rest of the Middle East. Another significant event was the widening of the spread between North Sea Brent and WTI crude. Historically, WTI trades USD 1.50 higher than Brent as the inferior quality of the latter makes the refining process more expensive. Recently, however, the spread has seen a dramatic widening with Brent at one point trading 15 dollars over WTI.
Apart from the well publicised over supply at Cushing where WTI is delivered, the timing of the widening could indicate Brent carries a political premium as it is considered the benchmark price in Europe, Asia and the Middle East. Despite only representing 2% of global production it is now the reference price of choice for almost 65% of global transactions. With the risk of the Libyan crisis spilling over to the Middle East the events have had a greater impact on the price of Brent than on WTI. On this basis, we can assume the spread will only begin to normalise once the current situation stabilises.
Should oil prices stay elevated above 100 dollars a barrel for a prolonged period of time, the impact on consumption and growth cannot be ignored. Back in 2008 the spike in oil prices no doubt helped bring about the subsequent recession. During that year WTI traded above 100 dollars for seven months averaging just below 120 dollars. Countries vary in their sensitivity to the oil price, but in the U.S., for example, it is widely believed that a 10% rise in oil causes GDP to fall by only 0.2%.
We expect the overall global pickup in consumption, combined with the political unrest and subsequent risk of supply disruptions, to keep oil prices supported during the second quarter. The downside risk is primarily coming from the investment community itself as the speculative long position in WTI, which reached a record 300 million barrels during March, compounds the risk of corrections like we saw after the Japanese earthquake. In the unlikely event of risk reduction by investors an unwound back to normal levels could result in a price drop of 10 to 15 dollars.
Agriculture
The drought related surge in food prices has continued into 2011 with agricultural prices rallying strongly during the first quarter, compounded by government hoarding in the MENA region. And that is before attention turned to the new crop season and who would win the annual fight for acreage. Favourable harvest projections in South America for soybeans, increased availability of wheat and lower Japanese demand due to a damaged infrastructure helped trigger a round of risk reduction during March. Average weather conditions in 2011 will not be sufficient to rebuild low inventories caused by the weather shocks in 2010 and, on that basis, we expect agricultural prices to remain elevated for the foreseeable future.
Given the outlook for very low stocks of corn and soybeans we continue to favour these over wheat during the coming months. A large percentage of U.S. corn production goes towards producing ethanol. This trade is profitable, up to 9 dollars per bushel, given the recent strong rally in gasoline prices. Meanwhile, soybeans remain supported by continued growth in emerging market feed demand.
Heating energy and base metals
Coal and liquefied Natural Gas will be supported in the aftermath of the Japanese disaster as Japan seeks alternative energies to replace lost nuclear production. The rebuilding process should also raise demand for base metals. Platinum and palladium was sold off during March on demand destruction from Japan as car production was halted. Depending on how soon production returns to normal, a pick-up in demand should support prices going forward.