Article / 04 January 2013 at 16:00 GMT

“Fiscal Fudge” provides short term relief to commodities

Ole Hansen Ole Hansen
Head of Commodity Strategy / Saxo Bank
Denmark

The dreaded US fiscal cliff which suppressed prices during December was this first week of 2013 replaced by what some choose to call The Fiscal Fudge. The US budget was agreed at the eleventh hour.  But with many of the contentious issues, such as finding the necessary funding, not resolved, the market was left unimpressed which meant that the relief rally lasted less than 48 hours. The US president will be facing further fiscal wrangling with congress over coming weeks as the debt ceiling will have to be raised again because the debt level continues to rise. 

Right on the heels of this, the US Federal Reserve surprised the markets by expressing some hawkish views in the minutes from its December Federal Open Market Committee (FOMC) policy meeting. In this, some members were showing increased unease about the side effects, such as financial stability and continued expansion of the central bank’s balance sheet. Some members felt it would be appropriate to slow or even stop further asset purchases well before the end of 2013. This was the first sign that the unease that has been growing outside the Federal Reserve for months is now also being felt within, and it makes 2013 an even more interesting year as the markets will have to decipher the effects of a transition away from cheap money. 

As a result of this, the dollar appreciation gathered further pace and commodities lost support, especially precious metals such as gold and silver which both had the rug pulled from underneath as they both have been thriving on the back of negative real yields caused by the low interest rate environment. Supporting the metals is the US budget compromise which will cause a drag on growth during the first couple of quarters. Nevertheless, the coming weeks will now seriously test the resolve of investors in precious metals and as a consequence, we may have to lower our 2013 average price projections for the two metals which are currently at 1840 and 34 respectively.   

The monthly US jobless reports are now even more important as every potential improvement in those numbers will help bring forward the markets’ expectations of when quantitative easing will cease. The numbers for December, which were released on 4 January, did not have any major impact given the fact the non-farm payroll came out in line with expectations while the unemployment rate rose slightly to 7.8 percent. 

Re-cap of 2012

Before moving on, let us take a moment to look back on how the sector performance table for 2012 ended up. Overall, the two major commodity index funds finished pretty much unchanged for the year, a disappointing result for long-only investors compared with other asset classes, especially stocks. A major correction in grains such as corn, wheat and soybeans during December resulted in a much reduced return for the grains sector but it still manage to outweigh the losses witnessed in softs, especially from the one-third drop in coffee, bringing the overall agriculture  sector return up into second position.   

 2012 sector performances  

Despite a decent rally across industrial metals during the final quarter, which were driven by an improved outlook for Chinese demand, the sector as a whole finished third ahead of the energy sector which suffered losses primarily from the negative performances of WTI Crude and Natural Gas which, on a (negative) roll adjusted basis, lost 30 percent. At the top spot we find precious metals not because of great individual performances but more due to the fact that all four components showed gains, especially silver and platinum. 

Mixed performances during the first week of trading

Nervous trading best described performance during the first shortened week of 2013, not helped by the fact that the dollar was up by more than one percent. Currency traders had overextended their long exposure to the euro, and it triggered a sharp reversal which led to a stronger dollar thereby creating some early headwind for commodities with the DJ-UBS index losing almost one percent. 

The only sector showing a positive return according to these indices was industrial metals, such as copper, which were helped by continued improved economic data out of China. The worst performing sector was agriculture with gains in livestock being offset by continued losses in grains and softs. Precious metals also experienced losses with gold, silver and palladium all in negative territory. The energy sector was also in negative territory, as gains in crude oil and products were offset by another heavy loss on Natural Gas.

 YTD performance  

Gold’s multiyear rally under threat

Almost before 2013 has kicked off in earnest precious metals have been confronted by several obstacles making this year one for a potential transition following twelve consecutive years of positive returns. Most damaging has been news about the unease within the US FOMC with regard to the duration of the current asset purchase programme. Continued improved economic US data will help bring forward the markets expectations of when QE will cease and this will knock the confidence among investors in precious metals. 

Gold did kick off the new-year with a rally inspired by the US budget deal but within 48 hours it fell to the lowest level since August 2012 and it has now been sliding almost continuously from 1800 USD/oz. - its October peak. ETP investors, who had begun the year holding a record amount of gold, and who up until now had used correction to accumulate, on Thursday pulled 327,000 ounces, the biggest one-day decline since September 26 according to Bloomberg. 

Technically, gold has moved back to the 1630 USD/oz. area from where it broke higher last August following a couple of months of sideways trading. This level coincides with the 61.8% retracement of the May to August rally and further weakness below this area would bring the next area of support at 1590 USD/oz. back into play. Gold investors’ and traders’ resolve and believe in higher prices over the year is about to face a big challenge in coming weeks as the current price action could indicate that a major top has now been established and one we potentially will not see again for a while.

 Spot Gold

For now though we still believe that the current move is just a correction also given the fact that market moves during the first couple of weeks of a new year often prove to be the wrong ones. But should 1525 USD/oz. be broken we will have a new situation and as a consequence we would have to lower our 2013 average price projections for the two metals which are currently at 1840 and 34 respectively.  

Crude oil range-bound despite signs of underlying strength

The price of Brent Crude has moved to the higher end of its current range not least helped by the improved outlook for US and Chinese growth and despite a rising dollar. Further support has come from the continued tightness in the spot market which has seen the premium of spot crude over the three month deferred move out to 2.8 USD/barrel. 

Spread to WTI Crude narrowing

The spread to WTI crude meanwhile has begun to narrow as expansion on the Seaway Pipeline connecting Cushing, the delivery hub for NYMEX WTI crude oil, with refineries around Freeport on the Mexican Golf coast is near completion. Once fully operational within the next couple of weeks the capacity of the pipeline will rise to 400,000 barrels per day from the current 150,000 and this should help alleviate some of the pressure on Cushing where supplies have risen to a record 49.2 million barrels due to increased production from unconventional methods. This supply glut has been one of the main reasons behind the dislocation in price between WTI and Brent crude which, although not perfect, currently best describes the global price level of crude oil. 

OPEC’s oil production fell in December to the lowest level in a year according to a Reuters survey. The drop of more than 1.1 million bpd from the April peak was due to dwindling supplies from Iran, now at the lowest since 1988, due to US and European sanctions while Iraq and Saudi Arabia reduced production amid slower global demand. This underlines the current state of the global market which looks well balanced and this should, barring any geopolitical event, keep the price range bound in the near term. Further upside seems limited beyond 115 while support can be found at 109.40 and 107.50.

 Brent Crude Oil

Natural gas sees biggest drop in three years

The abundance of US natural gas in underground storage together with an early January call for milder than normal winter weather up ahead sent natural gas prices over its own cliff on Wednesday. Within minutes the February contract flash crashed by almost 9 percent, the biggest drop in three years, reaching a low of 3.05 before recovering half of what was lost. With mild weather expected over coming days, demand could fall below the seasonal norm thereby potentially raising the level of available gas in storage when the injection season begins in two months’ time.  Elevated levels of natural gas in underground storage following last year’s mild winter triggered a slump in prices before a major switch from coal to gas helped stabilize prices. Concerns of a repeat will keep traders nervously looking out for changes in weather projections over the coming weeks.

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