Gold benefits; other commodities and equity markets collapse

It was turmoil in the financial markets last week following a combination of heightened concerns about global growth prospects, sovereign debt issues in Europe and the US, and fears of slowdown in emerging markets. Leading indicators have turned decidedly weak.

In particular, the US government debt issue and the threat of downgrade made headlines, while the sovereign debt markets in Euro area worsened with sharp rise in yields in Italy and Spain. Swiss and Japanese authorities have intervened to stem currency appreciation.

Little wonder that equity markets, oil prices and bond yields fell sharply (except in some European countries where yields have risen). Friday was the day when markets capitulated. At the moment, the sentiment towards risk remains extremely fickle and fragile.

While commodity prices covering energy and base metals fell sharply, the uncertain conditions favoured gold which has been the major beneficiary of the ongoing vagaries. Prices hit another all-time high last week as the external environment and investor sentiment remain supportive for the yellow metal. ETP holdings in July experienced the highest net inflow since May 2010, reports point out.

Interestingly, commodity demand seems to continue robustly despite weakening economic indicators. In many cases, the fundamentals are strong. Copper and crude for instance. Supply side issues for some commodities continue to create uncertainty and potential supply tightness.

Given the evolving picture, in the near-term, risks remain to the downside for industrial metals and energy products. The big question is whether there will be a well coordinated policy response. The quality of macro data from here on will also be critical.

It is important for commodity market participants to analyse the situation dispassionately. While in the short-term the situation appears gloomy and is cause for concern, the bigger picture in the medium-term remains fundamentally well supported on demand and supply side both. There are also those who see a silver lining in the hovering dark clouds of economic uncertainty.

The current pullback in prices actually provides an excellent opportunity for the Chinese to restock. Inventories with the Asian major have been depleting and it is only a matter of time before stocks are replenished. Will it happen now? Chinese domestic consumption has been running strong. Despite tightening credit in the country, commodity prices have held strong. If restocking demand emerges at the current relatively attractive price levels, there could be a rebound in commodity prices, especially base metals.

Gold: Without doubt, gold was the major beneficiary of last week’s financial market meltdown with prices hitting all-time highs. Hysterical headlines added to the clamour for safe haven assets. Earlier, the bullish sentiment was aided by significant purchases by central banks in Korea and Thailand. Of course, on Monday, the yellow metal faltered a little soon after resolution of the US debt debate; but there was no looking back from then on.

In the London market, the metal gained 1.9 percent over the week and on Thursday it touched a record PM Fix of $ 1680 an ounce. Friday PM Fix was lower at $ 1659/oz amid general liquidation. Week-on-week, silver was down 1 percent. Friday AM Fix in London was $ 39.24/oz, down a whopping 5.7 percent from the previous day’s $ 41.62/oz.

While gold’s price appreciation was certainly expected, the move upwards was fairly orderly despite the muted performance of the US dollar. This is a break from the recent consistent negative correlation with the dollar, commented an expert adding there was little resemblance to the strongly positive relationship to the dollar seen in 1H10.

Eventually, investor interest is the key to further price direction. The external environment is supportive. But, the physical demand is weak due to seasonal factors. So long as macro concerns persist and stock markets stay weak, gold will continue to remain a favourite of investors with potential to rise further. The move upwards will be not without corrections and profit booking. A decline in investor interest will result in temporary steep correction.

Base metals: Base metals finally capitulated on Friday with vast sell-offs across the board with zinc suffering the worst fate falling 5.6 percent. It was part of financial market panic that resulted in all round sell-off. Over the week, the picture was even worse. Nickel, zinc and tin recorded double-digit price falls.

Financial market worries have vitiated the sentiment in the base metals complex. Fears of slowdown in the developed world as revealed by leading indicators provide a further near-term downside risk to prices. The market is now anxious about emergence of Chinese restocking demand. With inventories low, the Asian major has to step into the market. Therefore, the recent price decline may prove to be temporary. In the event, current weak prices provide tremendous buying opportunity.

According to technical analysts, aluminium has scythed through support levels with ease and consolidation below 2450 would imply a further move to 2325/50 next. Copper closed below its 200-day trendline support implying a slide to 8750 or even 8500.

Crude: There has been immense downward pressure on prices in the wake of European sovereign debt crisis, US debt ceiling issue and apprehensions of a global economic slowdown based on leading indicators. There is so much noise in the short-term that the constructive bigger picture based on robust demand and supply tightness has receded into the background. Positive data and more benign macro environment will help fundamentals reassert themselves. The multi-million dollar question is how soon it will happen.

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