Commodities weekly: Correction hits gold and silver

This week China raised its key interest rate and speculation about US quantitative easing and the wider implication left the front page, at least for a little while.

The move initially stopped the dollar from weakening further with some commodities suffering setbacks as a consequence.

Gold is on course for its first proper weekly loss in almost three months while the energy sector continues to trade sideways to slightly lower. 

The Reuters Jefferies CRB index which tracks 19 leading commodities was flat on the week with big discrepancies between markets.

The whole agricultural space is still caught up in the weather-related storm that has swept around the globe these past few months. This has caused widespread disruption to production which in turn has seen agricultural commodities perform very strongly.

How strong can be seen on the below sector split from the Dow Jones UBS commodity index.

The overall performance of the DJ-UBS index is showing a year-to-date increase of four per cent which is primarily due to the weak performance of the index heavy energy sector which count for more than 30 per cent of the total index.

We have seen the correlation between strong gold and weak dollar increase recently. With the dollar finding some strength ahead of the G20 meeting in South Korea this weekend gold has come under some pressure resulting in the first weekly loss in three months.

It is during a correction phase that the underlying strength of a market will be tested and this is the situation we now have.

The next couple of weeks could almost decide whether the 2010 high have been seen already or whether this correction will attract new buyers who have been holding back waiting for such an opportunity.

As usual silver has underperforming during the correction just like it has been outperforming during the recent rally.

Support can be found down towards 22.18 and 21.34 which are Fibonacci retracement levels of the recent rally. The equivalent retracement levels for gold can be found at 1300 and 1272 with trend line support at 1,311 also worth watching.

A move back above 1,350 could signal a resumption of the uptrend with the next major target being 1,400.

WTI crude oil continues to find itself entrenched in a relatively tight range between 80 and 85 US dollars. The Chinese rate hike during the week scuppered another attempt at breaking higher as dollar strength sent it looking for support.

The speculative long position held by money managers such as hedge funds rose to near record levels last week and this would be a cause for concern.

A break below 80 US dollars could trigger some long liquidation resulting in a deeper correction.

A failure however to reach a deal to quell the global currency unrest at the G20 meeting in South Korea could be seen as being supportive for oil and other commodities as the dollar risk resuming its recent decline.

Natural gas slumped another four per cent this week as the weekly storage data from the US showed inventories continuing to rise at a faster pace than expected.

With the pickup in winter demand not expecting to outweigh supply for another few week’s inventories could reach the record levels seen last year adding. This is adding to the oversupply worries that have kept prices under pressure for months and have led to the forty per cent price drop year to date.

The long crude short natural gas ratio spread (WTI crude oil divided by natural gas) is a favoured value trade by many hedge funds and only a significant change in direction of this spread, which has seen crude outperform natural gas by 70 per cent since June, could bring some support back to the beleaguered market.

Turning to the agricultural sector we saw strong performances from coffee with the price of Arabica coffee beans rising above 2 dollars per pound for the first time in 13 years. This comes amid fears that adverse weather across key growing regions in South America will lead to further supply downgrades. Columbia, the second largest producer of Arabica, have already said that a fungus is damaging plants and may reduce the output for 2011.

Colombia had been expected to produce 10.5 million bags during the 2010/11 season but recent revisions have seen that reduced by ten per cent.

Combined with reduced output from Brazil, the world’s largest grower, demand could outstrip demand over the next twelve months by 1.3 million bags according to analysts.

Having rallied strongly since June the two dollar level reached this week could provide some near term resistance but demand from roasters will probably keep it supported on a potential setback.

The price of rice has also continued to rally increasing the focus on this grain which is the stable diet for more than three billion people across Asia. The main harvest in Thailand may drop by 20 per cent after the worst floods in four years hit the growing regions.

This has resulted in the Thai export price, which is the benchmark for the Asian market, having rallied ten percent from the July low and could rally another ten percent before year end as rice importing nations steps in to meet their needs.

A food crisis like the one in 2008 is luckily still very unlikely with the Thai benchmark trading at half the level seen back then. Continued weather developments have to be watched carefully as actual supply worries more than speculative interest have been driven these markets recently.

The January rough rice futures contract traded in Chicago reached 14.59 dollar per hundredweight this week and with seasonal demand picking up some analysts forecasting additional price rises towards the sixteen dollar level seen last year in December.

The writer is Senior Manager for CFD and Listed Products, Saxo Bank

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