Strong correction for commodities in July

Finally the US dollar is due for a continuation of the slight strengthening we have seen recently, principally driven by the Euro zone's rapid economic deterioration of late. Added to that, a major support to the euro will be mechanically removed, once the interest rate differential turns in favour of the US dollar.

Gold finds itself between a rock and a hard place, with a slightly stronger dollar on the one side and signs of lower growth on the other. The result has been a 10 per cent correction for gold over the past two weeks. And there is more downside to come, in the short term.

While some have been quick to talk up a speedy recovery for the US economy, we are not among the believers. Bank balance sheets are stretched as it is, but could really be tested to the full in the months ahead. In this tight credit environment, the second part of the year could be more challenging, especially if we see a creeping unemployment rate.

If central banks, in either the US or Europe, decide to hike rates it will be a decision, which in our view will have to be swiftly reversed. A rapid growth slowdown should be the focus for central bankers rather than a high inflation mark, which must decrease of its own accord in the coming months.

So what lies ahead? Gold will trade lower in the short term and the $900 level will give way. With this scenario, the 860 area should be the first target. But in our view, it is too early to adopt a bearish long-term view on gold, because faced with a large external deficit and a very favourable low rate in the US, gold should remain a valuable asset against a falling equity market and low bond returns.

ENERGY

The Department of Energy (DOE) statistics were not materially bullish or bearish. Crude oil drew 100k bbls, less than the consensus of 1.3m bbl; gasoline drew 3.5m bbls, versus the consensus of a 350k bbl build; and distillate built 2.4m bbl, more than the consensus of 2.0m bbls. The fall in gasoline prices is not a new turn up for books, as suppliers cut production and imports in the face of weak demand.

Last week showed a continued trend of crude stocks closing the gap relative to last year and the five-year average. Crude stocks now stand 50m bbls under last year's level and less than 20m bbls from the five-year average. At the beginning of the month, stocks were 60m bbls and over 25m bbls away from these marks.

OIL

July and August are typically marked by seasonal declines in crude inventories, but this year could be a turning point, with continued restraint in refinery throughput and extra Saudi Arabian supply arriving, we expect flat or building crude inventories.

On the trading side September crude oil price bounced from the $120/bbl level following the DOE release. The larger draw in gasoline was definitely the trigger, but on Thursday the oil bounce was stopped close to $128.00. We believe oil bounce should be limited around $130-135, if we get there at all, and another wave downwards should unfold towards $110 and $100.

The US unemployment figure will give price direction for the month, a sharp fall and we should trade towards $117 quickly despite a weaker dollar.

NATURAL GAS 

It seems traders have dismissed the idea of warmer weather in the US, with the strong correction in crude oil and natural gas trading close to 35 per cent lower from the peak at $13.75 on the July 2. This July correction has erased six months of gain in less than three weeks. It is not a contract for the faint hearted.

We have been quite bullish on natural gas in our previous letters, but admittedly the strength of this move has taken us by surprise.

We are now close to a strong support zone in the $8.70-8.30 area for the September contract amid oversold conditions. We will look to enter a long position as we expect a re-test of the 10.50 level. At current prices, natural gas will jump on any remotely bullish news.

AGRICULTURE

Corn prices to gain on lower conservation land release scheduled for 2009.

Last week the US Agricultural Secretary shut down market hopes that rested on them permitting land release from the Conservation Reserve Programme (CRP) next year, without applying penalties. Traders were expecting more land release from the CRP and, therefore, higher corn plantings to result in 2009.

This should help maintain the strength in corn prices, particularly given inventory-to-consumption ratios close at their lowest levels since 1974. However, corn returns still face an uphill struggle over the summer months in our view.

Since 1989, corn returns have declined 75 per cent of the time through June, July and September.

With odds like those, we would, therefore, caution against adopting a bullish stance on corn at this time. That said, we do recognise that even at current levels corn prices are low in real terms, particularly compared to price levels when inventories were as low as they are today. The oil correction in line with USD strength is obviously a weight on commodities, and grains are no exception.

Technically the 200 dma at $5.60 has proven to be a good repellent for corn. Furthermore on a weekly basis we could post a bullish hammer, if confirmed the 640 area should be next target, provided we hold above $5.97 (ascending trend line from July 24).

Sugar jumped close to 15 per cent in the last three sessions as yields in Brazil's main producing region dropped in the first half of July and ethanol yields rose, presenting a good sell opportunity. Sugar is closely correlated to oil prices and despite the advantage of being a greener energy is much linked to oil demand, so if the latter continues to fall we expect sugar to follow suit.

The October contract with an entry range around 13.50 area could be a good risk/reward with targets at $12.60, 11.80 and in a few weeks at 10.90.

We had some roller coaster moves on the yield curve in July with rates trading sharply lower on justified fears regarding the health and futures or Fannie Mae and Freddy Mac. Then it all turned sharply higher after some better than expected US earnings, and once again on Thursday some much higher claims numbers, sent the market into doubt before the US unemployment figure of today. By Friday, one theme had emerged following weeks of speculation: that rate hike expectations were few and far between.

We have a bullish technical on US and European 10-year rates with respective tickers at znu8 and fgblu8. Now, we sit and wait and look for a few full figure gains in both contracts in the weeks and/or months ahead.

-- The author is Strategist with Saxo Bank