Focus switches to fundamentals as the big freeze premium recedes

After the New Year rush to initiate long positions, commodity markets ran out of steam this week. The CRB index showed a flat return after a near four per cent gain during the first week of trading. The main sell-off came from grain and oilseeds followed by the energy sector.

The "frost" premium that helped drive energy prices higher at the beginning of the month has begun to evaporate as forecast for milder weather combined with another rise in inventories has taken prices lower. Market moves caused by weather shocks are by nature temporary, but the surge in demand has helped reduce booming inventories somewhat.

The Energy information Administration (EIA) this week released its monthly Opec surplus oil production capacity data. Excluding Nigeria and Iraq, they now have 4.7 million barrels per day of surplus capacity, the highest level since 2002.

Despite robust demand from emerging markets, the slower than expected recovery among the developed economies leaves little room for further upside near term. With the current surplus capacity Opec has signalled satisfaction with current price levels knowing that higher prices might damage the ongoing slow recovery. On top of this we have the risk of potential overheating of the Chinese economy, something that the government took the first steps to address this week by reining in lending and raising the cost of funds for lenders.

The long-awaited report from the CFTC on how it would curb excessive risk taking in energy markets was released on Thursday. The new rules would affect crude oil, natural gas, heating oil and petrol, but as it turned out the new limits would probably only impact the 10 biggest position holders. So it is a pretty measured response with the main impact being felt by hedge funds and index funds.

Technically crude oil for near month delivery made a new 15-month high at $83.95, but the subsequent strong sell-off indicates that the market is not currently ready for an attempt on $85 and beyond. Considering the 18.5 per cent rally since the middle of December last year a correction was overdue.

We are currently looking for $78.08 and $76.27 as good support levels in a market that increasingly looks like it wants to range trade around $80 until we see further reduction in the overhang of supply.

The gold rush of 2009 was put into perspective this week as a leading precious metals consultancy said that the investment demand for gold had doubled to 1,820 tonnes last year, while jewellery purchases fell 23 per cent to 1,687 tonnes. This is the first time in three decades that investment demand exceeded that of jewellery demand and it highlights the huge role that investors played in driving gold to a record high in 2009.

Jewellery demand is expected to stay subdued above $1,000, according to traders, which puts the focus firmly on the need for continued investment demand in order to drive prices higher over the coming months. Global mine supply only rose by six per cent to 2,553 tonnes, a six year high, while net sales from central banks dropped 90 per cent to 24 tonnes, the lowest level in more than 20 years.

Overall new net investments into commodities rose by $50 billion, a new record according to JP Morgan. It illustrates clearly how this growing asset class is being viewed by investors and currently the expectations are for a similar amount to be invested into the sector in 2010.

Gold like energy prices failed to hang onto the gains made early this week. On one hand it is being supported by continued investment interest, but worries about a potential revival of the dollar on the back of European woes could hurt the euro and thereby potentially gold as well. The economic problems facing countries around the Mediterranean and Ireland is well known and a continuation of the dollar's month long slide can no longer be taken for granted. Overall the uptrend is still intact above $1,055 but gold looks to be in a consolidation phase for the time being. Look for support towards $1,115 followed by $1,086 and resistance at $1,146 and $1,162.

Silver, meanwhile, has managed to hold onto its recent gains showing a near 11 per cent gain so far this month with $18 proving to be a major support level. The gold to silver ratio has dropped from 65 to 61.2 currently with additional room for silver outperformance down towards 60.

The major moves of the week took place among grain and oilseeds products, which tumbled on Tuesday after the USDA released its WASDE (World Agricultural Supply and Demand Estimates) report, in which it surprisingly raised yield forecasts to record highs. Planting delays last year that delayed the growth window were more than offset by a mild summer and a warm dry September that helped the delayed crop to maturity.

This surprise change in forecast prompted a dramatic sell-off across the board with corn reaching the allowed down limit for the day and continued lower the following day. Because the US exports half the world's corn, a third of the world's soybeans, and a fifth of the world's wheat, changes in output there have a major impact on global prices.

The reason why the upward revision came as such a surprise is due to the bad weather that the Midwest has experienced during these past few months. For exactly this reason some worry that the next figures due in March could be revised lower as a portion of this season's corn crop remains stuck in the ground due to unusually wet weather.

We see some upside to corn now after speculative long positions have been reduced, but favour a relative value trade versus wheat around the current ratio of 0.72 going for a target towards 0.79. Corn will be supported by the continued use in ethanol production while wheat supplies are abundant.


- The author is Senior Manager for CFD and listed products with Saxo Bank. The views expressed are his own

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