Expectations overlap current reality

Better than expected corporate earnings saved the energy sector this week after crude on Wednesday had its biggest drop in more than three month as data pointed to a system increasingly oversupplied.

The commodity sector and especially energy ran into a brick wall on Wednesday as they were hit by a series of non-friendly news. The dollar halted its recent slide, the Chinese stock market went into reverse and the weekly storage data showed a surprising strong increase in crude stocks.

The recent dollar selling against the euro ran out of steam as the pair failed to breach the June high at 1.4330. Commodity markets continue its strong link to dollar moves and this removed some of the recent support.

China sneezed as its stock market saw a big one day sell off on news that bank lending had to be reduced to avoid the system overheating. This led to the usual worries that China's strong demand for commodities could be reduced.

The contango on WTI crude future, which is the time spread between two contracts, has begun to move higher again and was lent further support on the news that Cushing, the storage point for Nymex WTI crude, saw an increase of 1.3 million barrels to 32.12 million which is close to the February high of 34.9 million. The spread between September and October touched $2 after having traded as low as $0.5 back in June.

Another rise of cushing inventories will be difficult for the market to overlook and could lead to further widening of the contango and the spread between North Sea brent crude and WTI crude. September Brent has this month outperformed September WTI crude by more than $4.

One Investment Bank estimates a total of 140 million barrels of crude is currently stored offshore which equates to 70 VLCC (very large crude carriers) as demand from developed nations continue to lag behind production. A lot of crude surplus has gone into the production of refined products these past few months but the same lack of demand has pushed stockpiles to daunting high levels.

It is clear that current news and statistics do not support prices but the rally in stock markets on expectations that the global economy has turned a corner and will pick up steam in 2010 is a theme favoured by many hence the current stalemate between $60 and $70.

For now the strong positive reaction on Thursday to better-than-expected company results from a phone, cookware and a writing instruments company illustrates the current sentiment that future expectations overrides the present reality. Failing to reach $1,000 on the S&P 500 index, however, could be the trigger for renewed weakness.

Technically the September crude is stuck between $59.30 and $70 with the downside being favoured. Some support should be found at $61.50 ahead of the recent low at $59.30.

Gold found sellers above $950 as disappointed investors took the opportunity to reduce positions after the recent rally and switched into equity markets instead. This has also been reflected through the holdings in ETFs which has seen the biggest monthly outflow of investments since April 2008.

IMF announced they plan to sell 403 tonnes of gold within a new European Central Bank gold pact currently being negotiated. Market impact seems to be limited as the sale will be spread out over two-three years and will be part of a new Central Bank Gold Sales Agreement which should be finalised by October.

Technically spot gold is in a triangular formation with the current range being $916 to $980 with near-term support being 100-day moving average at $925 and resistance at $942 and $960. Sooner or later, the recent rally in stock markets will have to be tested and that should lend investors a hand but as talk of inflation get pushed further out we would expect additional long liquidation on any rallies. The price of Sugar continues to rise and the 2006 high of $19.73 is now within reach. Last time we were up here where at the height of the early ethanol craze when sugar suddenly found itself loved not only by chocolate producers but also by dual fuel car owners.

The recent rally has been weather related as the annual monsoon rain in India, the world's largest consumer, has been below average combined with the opposite problems in Brazil where excess rainfall has lowered yields. This has led to speculation that India will have to double their imports to five million tonnes. Sugar has now rallied more than 45 per cent and is the third most rising commodity in 2009. Other agricultural products to keep an eye on are corn and soybeans. Soybeans especially shifted up one gear during the week rising the most in nine months while corn seems to have found a base after the recent round of weakness.


- The author is Futures and Fixed Income Manager with Saxo Bank