After the RBA’s rate hike at the October meeting, biggest topic in the market has been ‘who’s the next central bank in the developed world to tighten monetary policy?’. While analysts have diverse opinions on which of RBNZ, BOE, ECB and BOC will be the next candidate, the majority anticipates the Fed to keep its unprecedentedly low policy rate at 0-0.25% until 2Q10 and BOJ’s 0.1% rate will stay even longer.
Interest rate differential continued to pressure USD. The dollar index plummeted to 14-month low at 75.996 Thursday before rebounding as investors took Fed Chairman Ben Bernanke’s speech as hawkish. The dollar index declined -0.7% on weekly basis. Weakness in USD drove demand for commodities and the Reuters/Jefferies CRB Index surged +3.8% to close at 262.55.
Crude Oil
Crude oil price was under pressure amid USD’s rebound earlier in the day. However, price pared losses after the International Energy Agency (IEA) upgraded the demand outlook for 2010 for a third consecutive month. The benchmark contract eventually settled at 71.77, adding +2.6% on weekly basis.
The US Energy Department (EIA) and the International Energy Agency released monthly reports last week. Both agencies revised upward their outlooks on world oil consumptions amid improvement in macroeconomic outlook.
The US Energy Department forecast crude demand will increase to 84.77M bpd in 2010 after a drop to 83.67M bpd in 2009. The 2010 forecast was +0.18M bpd above the projection made in September. However, the Department did not change the forecast on WTI crude oil price which remains to be 75/bbl by December 2010.
The International Energy Agency anticipated global oil consumption would rise to 86.1M bpd in 2010, +1.7% yoy as driven by +3.6% demand growth in developing countries while ‘demand from the world’s developed economies is expected to remain stagnant in 2010 after falling -4.5% this year’. The estimate was +0.35M bpd higher than the projection made in September. IEA also upgraded its 2009 consumption forecast to 84.6M bpd, -1.9% yoy. In September, the agency anticipated the demand will drop -2.2% on annual basis.
2 weeks ago, a meeting was carried out between permanent members of the UN Security Council and Germany, and Iran regarding Iran’s nuclear program. Unexpectedly, the meeting was ‘peaceful’ and the progress was better than expected. Iran agreed to let the International Atomic Energy Agency (IAEA) visit the Qum site on October 25. Moreover, Iran agreed to send most of the LEU stockpiles to Russia for further enrichment and then to France for medical research purposes. The deed aims at lowering Iran’s LEU level to what is required for making nuclear weapons.
The geopolitical tension between Iran and the world did boost oil buying. However, how serious is its impact on oil supply and price? In our view, the disruption on oil production is not that severe and the therefore, the impact on oil price is not too much.
Take the invasion of Iraq in 2003 as an example. In Iraq, oil production dropped -36% yoy to 1.34M bpd in 2003. However, oil production in the country had been falling -16% yoy to 2.12M bpd in 2002 and -4% yoy 2.52M bpd in 2001 after making a 20-year of 2.61M bpd in 2000. More importantly, crude production rapidly recovered +50% to 2M bpd in 2004.Concerning oil price, WTI crude rose +6% a week after the war began. However, the rally slowed down and eventually reversed to a fall of -12% in less than 2 months’ time.
Natural Gas
Natural gas price dropped -3.9% to settle at 4.77 Friday. Although the benchmark contract gained +1.1% on weekly basis, outlook remains uncertain and gas price should continue to trade with high volatility.
The US Energy Department forecast that total natural gas consumption will drop -2% in 2009 and -0.2% 2010. There compare to the estimates of a decline of -2.4% in 2009 and 0% in 2010. According to the Department, ‘weak economic conditions continue to hamper the industrial sector, where the most recent data show natural gas consumption is down by -12.4% through July compared with the same period last year. With lower consumption in the residential and commercial sectors as well, natural gas use in the electric power sector continues to serve as the only demand outlet for increased natural gas supplies’.
Natural gas has rebounded strongly in recent weeks. However, we believe price should remain at low level for some more time so as to improve the fundamentals.
US gas storage increased +69 bcf to 3658 bcf in the week ended October 2. The level is +15% above 5-year average. Although the number of gas rigs has dropped more than -50% from its peak in September 2008, recent data form Baker Hughes’s data showed building of rigs over the past few weeks. We believe drilling activities pick up because of rise in gas prices.
On the demand side, the EIA stated that ‘electric power sector continues to serve as the only demand outlet for increased natural gas supplies’. However, further increase in gas price suggests that gas will lose its place to coal and the last resort for the abundant gas storage will disappear. Therefore, we’d prefer gas price to fall more in coming month so that the demand/supply outlook can be rebalanced.
Precious Metals
Comex gold halted the 5-day rally by retreating -0.7% Friday. Settling at 1048.6, the December contract surged +4.4% over the week. Last week’s rally was impressive as gold has broke above the peak made in March 2008 after trading below it for one and a half years. The breach was decisive and price closed above it over the past 4 days.
The retreat last Friday was driven by USD’s strength amid speculations that the Fed will increase interest rate sooner than previously anticipated after Chairman Ben Bernanke’s speech. Investors probably seek more evidence about economic recovery after the RBA hiked its policy rate earlier in the week. In fact, Bernanke’s stance has not changed from what he said in WSJ in July. Meanwhile, a pullback or consolidation in gold price is warranted due to long liquidation. However, we remain bullish on gold price in the long term.
Major reasons driving gold’s rally are weak USD, inflation expectations and minimal sales from central banks.
The Fed has reduced the policy rate to 0-0.25% since late 2008, making it one of the countries offering the lowest funding rates. Last month, USD ‘took over’ Japanese yen as the funding currency for carry trades as the LIBOR rate for USD has dropped below than of yen. G-17’s non-intervening approach to USD’s depreciation and RBA’s beginning of the tightening cycle put further pressure on the greenback and the dollar index will likely resume its long-term downtrend soon.
Although global central banks have been emphasizing that inflation outlook is subdued, investors do not seem to hold the same view. US’ University of Michigan survey showed that consumers anticipated inflation will reach +2.2% in a year, significantly above the current level while UK’s inflation attitude survey by the BOE showed that consumers expected inflation to reach +2.4% in a year.
While IMF’s sales of 403 metric tons gold in coming years does remain as an overhang to gold price, we do not believe it will have any material impact to gold price. As we mentioned before, the sales will be carried out in 4-5 years at market price and the IMF will ensure it will not cause fluctuation in the gold market. IMF’s gold sales will be compensated by gold buying in central banks. Given the huge budget deficits in the US, global central banks have been diversifying away from USD. By August 19, gold sales under CBGA II were 149 metric tons, compared with 358.3 metric tons in 2007/08 and 475.8 metric tons in 2006/07.
Among the above drivers, USD’s weakness is the most prominent one is pushing gold high. In the chart below, the regression line for September data has higher slope than the one for June- August data. This suggests the dollar impact on gold has been stronger than before.
Silver amplified gold’s rally and became the best performer in the precious metal complex last week. In fact, silver price rallied +65% since the beginning of 2009, compared with +21% in gold. Certainly, it was to a large extent a catch-up play as silver plunged -26% while gold gained modestly in 2008. Although gold price has broken its 2008-high, silver, after the +9% rally last week, remained -17% below its record level.
Investor Jim Roger said that silver should have better growth prospect than gold in the precious metal complex as industrial demand on these metals will increase as global economy recovers.
At the end of 2008, gold-to-silver price rose above 80 as silver price plummeted. Recently, the ratio has fallen to around 60. We believe the ratio lies at a fair level now. However, as both gold and silver rallies have been driven by robust investment demands, deeper correction will probably be seen in silver than in gold as positioning in the former is more stretched.
Base Metals
The complex rebounded strongly last week as driven by falling USD, strong equity market as well as some industry specific good news. Alcoa, the largest US aluminum producer, surprisingly reported profits of $77M in 3Q09. Although the figure represented a decline of -33% from the same period last year, it exceeded market expectation of a loss. Concerning demand outlook, the company said the end-market has started to stabilize and demand is improving. Potential production disruptions also helped boost metal prices. BHP, the world’s largest miner has been facing potential strike as its Chilean copper mine as workers demanded for a wage raise. Over 20% of copper-mine output will be affected in 3-6 months.
China will release the preliminary trade data for September and we should see further decline in imports. This remains an overhang for base metal prices in the near-term.
Source: Oil n Gold