Commodity market awaits US Fed decision on tapering asset purchases

Are market concerns of Fed tapering premature?

Global commodity markets are at the crossroads of high liquidity and slow demand growth even as data available so far for the second quarter of this year suggest that global GDP continues to expand moderately.

The engine of global growth, the US, shows positive signs of economic activity and gradual, even if painfully slow, fall in jobless claims.

The critical question is how soon a decision on tapering asset purchase will be taken. This question arises simply because anticipation of Fed tapering is the key driver of financial markets at present. Questions are also being raised whether some commodity markets have over-reacted to the imminent scale back of quantitative easing (QE3, the timing of which is as yet uncertain) and thus overshot to the downside at present.

The release of May non-farm payrolls on Friday showed that the US economic recovery remains weak, although it also helped reduce fears of an abrupt slowdown.

Commodity market participants believe that the Fed may exercise the last option at some stage simply because of the risks associated with a larger balance sheet.

It is under these highly uncertain conditions that many are conjecturing about the timing of asset purchase tapering. No wonder, in the commodity market, fundamentals are coming to the fore. Prices are being increasingly driven by market balances.

Last week was mixed for precious metals and base metals.

While platinum was the top performer with 3.2 per cent price gain, palladium was up 1.3 per cent. Silver was nearly unchanged over the week even as gold slipped 0.6 per cent.

Among base metals, lead performed badly with a fall of 2.4 per cent followed by copper and zinc while aluminium (1.4 per cent), nickel (1.5 per cent) and tin prices gained week on week. Oil WTI was up 3.5 per cent.

Gold: The market is torn between fear of Fed tapering and resultant decline in investor interest and ETP outflows on the one hand and healthy physical demand conditions after the April price correction on the other. Prices have hovered around the $1,400 an ounce mark with the market focus is buffeted by macro and trade data as well as dollar dynamics and import duty hikes. In London on Friday, gold PM Fix was $1,386/oz, down from the previous day’s $1,400/oz. Silver edged marginally lower with Friday AM Fix at $22.60/oz versus previous day’s $22.62/oz. Platinum ended the week at $1,505/oz and palladium $754/oz.

The question is whether gold price fall has run out of momentum. While ETP outflows continue, they have slowed. Speculative positioning in the yellow metal is also rather pessimistic with CFTC gross short positions at an all-time high and smallest net long position since 2007. This makes a mild recovery in prices possible in the weeks ahead although timing of Fed tapering will be decisive.

At the same time, one cannot overlook the fact that ETP outflows since April have reached 135 tonnes and the period of seasonally weaker demand has kicked in. The slowdown in physical demand is likely to be greater than the slowdown in investor demand with resultant effect on prices.

\While on this, with a view to curbing gold imports, the Government of India has hiked customs duty on gold imports to eight per cent from six and imposed a substantial restriction on consignment imports.

Banks have been advised not to aggressively promote sale of gold coins. To what extent these measures will help arrest gold imports remains to be seen.

Meanwhile, the Indian rupee has depreciated, pushing the landed cost of the metal higher, and denying consumers the full benefit of the fall in gold price in dollar terms.

Base metals: The market seems to be going through a period of introspection and appears less-supported. While Fed tapering looms, lack of growth impulses and demand is a concern.

Going by macro data, Chinese economy is less supportive than it used to be. No wonder, prices are under pressure. On Friday, LME cash aluminium was $1,903/t, copper $7,198/t and zinc $1,869/t.

The copper market is projected to move into surplus on improved supplies in H2 this year. So, selling rallies in copper is advisable. Moves above $7,500/t provide opportunity to short copper on a likely slowing in Chinese consumption over the summer months.

In the case of aluminium, as short covering seems to have driven prices above fair value, fundamentals along with producer selling will drive a correction lower.

According to technical analysis, copper momentum is bearish. Resistance is seen at $7,500 and $7,300 while support is seen at $7,200 and $7,100. Bearish risks are increasing for zinc and aluminium.

Crude: Last week, crude oil markets largely retraced the losses from the previous week and prices are likely to gradually recover towards the end of the month with rising summer demand.

Speculative positioning in the US oil market remains heavily on the long side, although investor interest in other commodities is low. Technically, in the near–term, a choppy 99-105 range continues to dominate Brent prices and the chop is likely to continue through August.

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