Crude may rise; base metals to slide.

Output cuts in crude, steel, select base metals, etc will also begin to tighten demand-supply balances.

G. Chandrashekhar

Mumbai, Jan. 11The big question facing every commodity trader and investor around the world is whether the surprise rallies that greeted the New Year would sustain. But the flow of economic data strongly suggests it may be too early to expect any significant and sustained bounce-back in commodity prices.

Rising inventory levels and lacklustre demand continue to haunt the markets. When exactly in 2009 would economic data start to improve is increasingly becoming a matter of conjecture. But all is not lost. Importantly in recent weeks there are clear signs of change of investor attitude. The frenzied risk reduction that marked the last 3-4 months may perhaps be coming to an end.

Net non-commercial length across all US commodity markets has risen sharply over the past three weeks and is now back at levels not seen since early-October. Commodity index trader positions have also now bottomed and are starting to pick up even as there is a substantial pick up in the commodity exchange-traded product (ETP) market, point out experts. But one must wait for clearer trends to emerge. The various bailout and stimulus packages announced by countries (mainly US, Europe, and China) have to begin to show results. Output cuts in crude, steel, select base metals etc will also begin to tighten demand-supply balances.

The movement of the US dollar will have a strong bearing on commodity prices, so also will inflation. Across markets, therefore, volatility is likely to pervade for some time yet. It is in this increasingly uncertain short-term scenario that traders and investors have to operate.

Gold

Prices are held up at the mid-800 levels. Where prices travel from here depends on whether investors continue to turn to gold. There are several reasons for investors to favour the yellow metal, not the least of which is the expectation that the dollar will weaken vis-À-vis the euro over the coming several months. Flow of economic data will have a bearing on the market. In addition, crude has the potential to gain up to 50 per cent from the current levels gold and an inflationary environment may begin to build later in the year given low interest rates and rising liquidity. These factors are likely to support an uptrend in gold prices over the coming months. The year 2008 meant an exceptional physical investment demand in gold with total holdings across the 15 major ETPs closing the year at a record 1,193 tonnes. Retail sales of coins and small bars also soared.

On the other hand, rising prices are sure to cause demand compression in price conscious markets such as India. Already there is evidence of a decline in India’s gold imports. As and when stock markets witness a strong rebound, there is risk that investors may turn attention away from the yellow metal. On Friday, the PM Fix for gold in the London spot market was $847.25 and ounce, down from $855.75/oz the previous day. On the other hand, silver moved up to $11.22/oz (AM Fix) on Friday from $10.88/oz the previous day. Despite conditions staying propitious for a spurt and in fact breach of $900/oz, gold has decisively failed to do so in recent weeks. In the short-term it could come under pressure amid a deflationary environment or during bouts of dollar strength.

According to technical analysts, gold left a clearly two-sided week in place given the lack of bullish and bearish follow through the last few sessions. The near-term vulnerability remains despite lack of traction over the past few sessions. The risk is for a pullback towards 810/800 (100-day average and trendline support) ahead of a base. In the medium term, the market may operate in an erratic range of 700-930. Above the range high is needed for a run at 1,030 and beyond.

Base metals

The complex ended the first week of the New Year on a strong note with prices up across the board, with double-digit increases in most cases. Traders attributed this to better than expected US jobs data, although the data still showed the US lost another 524,000 jobs during December, with the unemployment rate rising from 6.2 per cent to 7.2 per cent. During 2008, the US economy shed 2.6 million jobs, including 2 million in the last four months of the year. It is also reported that buying for index rebalancing could be one cause of the pick up in prices. Lead had a phenomenal week with prices up by nearly 10 per cent on the back of strong import purchases from China, and Europe too. But the bigger picture is far from encouraging. Macroeconomic conditions do not inspire confidence. With no improvement in near-term fundamentals, there is little reason for price increases to sustain. Indeed, rallies may be opportune time to sell into.

In case of copper, market fundamentals, especially the demand side continues to deteriorate. This metal may have the furthest downside potential from current levels. According to experts, copper prices are still above production costs and miners still make money. Therefore, there would likely be cost-related cutbacks in production. On the other hand, aluminium, zinc and nickel prices have all fallen very close to weighted average production costs. There is growing risk that copper could dip near to this level at $2,100/t.

Crude

Although crude prices have fallen back after rallying on the back of geopolitical tensions, there is now a sense that quantitatively supply cutbacks are greater than demand compression. Importantly, the ongoing OPEC cuts should start to tighten oil balances over the next three months, even if demand stays weak. When growth concerns begin to wane and recessionary conditions give way to recovery, crude market can face a substantial supply bottleneck. That would pave way for a spurt in prices. In Q2, prices could potentially move above $50 a barrel. The upside risk is accentuated by dollar weakness and geopolitical developments that can lift prices.

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(This article was published in the Business Line print edition dated January 12, 2009)
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