G. Chandrashekhar

Mumbai, March 22

Commodity markets have yet again lived up to their reputation for volatility with macroeconomic developments, rather than demand-supply fundamentals, providing a boost in the last few days.

After languishing at relatively low levels, commodity prices, led by crude, have begun to move up. The Fed’s surprise decision to announce quantitative easing - buyback of government debts - has had a profound impact on the dollar which has dramatically weakened, while the equity market has begun to move up.

The inflationary impact of the Fed’s stance is also on top of market’s mind. As a hedge against inflation, hard assets are likely to interest investors.

While it may be premature to announce there is a recovery in risk appetite, the indicators from equity and commodity markets suggest the possibility; but one may have to wait for some time for confirmation. Is the turn of sentiment for real and will it boost demand for commodity exposure?

To be sure, the current move up is clearly dictated not by market fundamentals of demand-supply, but by a host of non-fundamental factors including government policies, expectations of improving liquidity and currency movements. Obviously, different commodities are likely to behave differently in their price performance. Caution is advised.

Gold

Last week saw big bounce back in the yellow metal after the Fed announced it would begin buying longer-term US Treasuries. The USD weakened considerably vis-À-vis the euro and was the weakest since early January. The announcement had implications for improved liquidity and inflation. No wonder, investor interest in the precious metal picked up.

Fresh inflows into exchange-traded products emerged. Total inflows for the year are up 389 tonnes, exceeding net inflows for the whole of last year by 67 tonnes. Holdings across the 15 major physical products have now breached the 1,600-tonne level.

On Friday, the metal witnessed a modest pullback. In London, the PM Fix was $954.00 an ounce, marginally down from the previous day’s $956.50/oz.

On the other hand, silver gained on Friday moving up to $13.65/oz (AM Fix), from $13.13/oz the previous day.

In the medium-term, conditions for a rally in gold beyond $1,000/oz are developing. Weakening of the dollar and inflationary expectations are sure to force investors to favour gold as a hedge. However, it is a matter of deep concern that physical demand in major markets (such as India and Turkey withprice-conscious buyers) is suffering because of high prices.

For instance, India’s gold import last month was zero. So, it looks like the market is driven by non-fundamental factors such as currency. A further pick up inequity markets will lure investors away from gold. In the event, the downside risk to gold prices cannot be wished away. According to technical analysts, there is a near-term upside bias.

Momentum remains supportive; and with the dollar under pressure, one could look for a break of 965 resistance to test the year highs at 1,005. However, within the precious metals sector, gold looks set to be a laggard as both platinum and palladium are outperforming, analysts asserted adding of the two, platinum looks to have the most potential as the gold/platinum ratio is on the verge of completing an impressive top.

In the medium term, a gold breakout above 931/44 targets a run beyond the high at 1,033 to 1,200.

Base metals

The complex was generally up strongly over the past week, with aluminium surprisingly out-performing others. The metal posted a growth of 8.3 per cent week-on-week, while copper rose 7.7 per cent and lead moved 7.4 per cent higher.

On Thursday, 3-month copper prices rallied to over $4,000 a tonne, but drifted lower on profit taking.

Most other metals followed suit. The dollar depreciation, recent rally in copper and announcement of Chinese province Guangxi (a major aluminium producer) plans to buy 50,000 tonnes of primary aluminium were all supportive.

On the other hand, there are concerns relating to demand. Euro zone industrial production has been contracting at a rapid rate from the beginning of this year. Overall, support from the physical market does not show any sign of improvement. .It appears the rally has taken base metal prices to levels that look unsustainable given the lack of improvement in the fundamentals.

Some metals are over-valued and a pullback is a distinct possibility. At the same time, given that some base metals have been heavily shorted, short-covering rallies are not ruled out.

In copper, it may be worthwhile to wait for a pullback to a low $3,000 before going long; and in aluminium, selling into (short-covering) rallies is advisable. Lead may be ready for a pullback as the rally is overdone, while nickel may trade range-bound because of weak stainless steel market.

According to technical experts, while allowing for corrective weakness, as overbought momentum unwinds, the upside focus remains. With the speculative community still in the process of unwinding short positions, the upside potential should not be underestimated. Initial targets are seen at 4,366/4,547. Short term support can be found at 3,725/3,671, with a move below needed to warn of a greater correction.

Crude

The wave of bullish sentiment that swept the commodity market last week following various measures announced by the Fed helped support prices even as oil was no exception. With WTI trading above $50 a barrel for the first time this year and value of OPEC crude basket having moved above $45 from early January, there is a shift in the sentiment.

Experts assert that straight forward negativity towards the oil market has now given way to somewhat of a nuanced judgment of supply/demand fundamentals. Even dire warnings of negative global GDP growth have not really deterred the market.

Clearly, far from declining, demand is stabilising. Although global demand stays weak, it is not getting worse. Experts forecast year-on-year fall of two million barrels a day in the first half of 2009.

Crude oil inventory overhang is eroding and in recent weeks, stocks are beginning to show signs of tightening.

With non-OPEC output growth slipping and OPEC members respecting the output quotas, supply cutbacks are greater than demand side weakness. A weak dollar is supportive.

For the second quarter (April-June 2009), an average price of $50 a barrel looks eminently possible. Crude could move 10 per cent on either side that is between a low of $45 and a high of $55 in the coming months. For Q3, the average may rise further to around $60 a barrel.

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(This article was published in the Business Line print edition dated March 23, 2009)
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