Persisting uncertainty about resolution to the European sovereign debt crisis and fragile market confidence in the wake of less-than-satisfactory macro picture have combined to place downward pressure on the global commodity markets.

Last week saw prices of a range of commodities covering energy, metals (precious and base) as well as agriculture decline in line with the negative sentiment.

Crude is caught in a conflicting position - between a weak macro view and supportive physical market fundamentals. Currently, there is fear of demand destruction if the economy takes a downturn. Gold is struggling to gain traction or extend gains despite supportive conditions. Need for liquidity and risk aversion seems to outweigh investment appetite. Base metals have displayed volatility because of apprehensions over growth.

It is likely that commodity investors are expecting the worst as evidenced by their exit from some markets. Institutional investors and hedge funds are reported to have been aggressive in liquidating positions. The metals markets covering base and precious metals have borne the brunt of the sell off.

Good news comes from steel. In September, global crude steel production rose by 3 per cent month on month and 10 per cent year-on-year to 1,503 million tonnes on an annualised basis. However, China's output was down month on month. A factor contributing to the current weak sentiment is the apprehension that the US commodity futures market regulator CFTC may tighten trading conditions by imposing positions limits and so on. This can potentially discourage speculators.

Sunday's EU summit to address the debt issue is likely to prove crucial as the outcome will provide a direction for the markets. As one analyst pointed out, this week may be momentous for the financial markets.

However, notwithstanding the poor sentiment, it is becoming increasingly clear that once growth signals turn positive, those commodities with tight fundamentals are sure to benefit from a quick rebound in prices. Crude, copper, aluminium and corn are widely seen as commodities with the highest price performance potential.

Gold: All precious metals were under pressure last week facing decline in value. Gold lost 2.1 per cent week-on-week, while silver declined by 3.2 per cent over the week. In London on Friday the gold PM Fix was $1,643 an ounce, up from the previous day's $1,620/oz. Technical short-covering ahead of the unpredictable Euro Zone meeting over the weekend was cited as reason for the small rally.

Clearly, gold has been struggling to extend its gains. Need for liquidity has also prompted less committed investors to exit the market. However, the backdrop is surely gold positive. Seasonally-driven physical demand at the current relatively lower prices is cushioning the downside. In the short-term, however, risk aversion and liquidity may put further downward pressure. That said, an evolving inflationary environment and any currency debasement that may follow any cure for Euro Zone woes will be highly supportive for the yellow metal. In case of silver, its weak fundamentals expose the metal to downside risk in the absence of strong investor demand.

Base metals: All LME metals were down week-on-week with base metals prices showing volatility due to poor sentiment arising out of weak macroeconomic backdrop, uncertainties relating to European debt crisis and apprehensions over Chinese slowdown. On Friday, however, LME base metals bounced back with copper rising by over 6 per cent.

Analysts said there was no obvious catalyst and the rally may have been driven by technical short-covering. Cash LME copper price was $7,137 a tonne, while nickel was $18,771/tonne. Lead too rose smartly to $1,891/tonne. Tight inventories, spot purchases by China and supply constraints are likely to combine to propel copper higher in the event the macroeconomic picture brightens. Aluminium too is seen having constructive medium-term fundamentals. Lead prices have the potential to recover if the Chinese lead battery sector recovers.

Crude: Volatile trading marked crude oil market last week. While the physical market is supportive, the macro backdrop is not. “Prices were caught between fickle macroeconomic sentiment and having to unwillingly place strengthening underlying fundamentals to the backseat” is how an expert described the situation.

Low spare capacity, falling inventories, continuing geopolitical risk and large supply deficit create conditions for a surge upwards, but for macroeconomic fears.

(This article was published on October 23, 2011)
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