Alan's Finance Blog

A Way to Profit from Big, Unpredictable Market Moves

In chess, it is said that you need to think three moves ahead.

I’ve played a lot of chess in my day, and I can tell you this is easier said than done. Just when I thought I’d figured out my opponent’s next move, he’d change things up on me.

I baited him once with my bishop. Instead, he took my pawn. It was an unexpected variable that redefined the outcome of the game.

I quickly learned that it’s much more important to develop strategies that can improve your position rather than trying to predict potential moves.

Investing is a lot like chess in that way.

If you think an asset will go up in price you buy it. If you think an asset will go down in price you sell it.

But what happens when you expect the price of an asset to move big… you just don’t know if it’s going to explode or go in the tank?

That’s the situation commodity investors find themselves in today. With all of the volatility in the markets these days, identifying how a commodity’s price will swing is difficult to pinpoint.

But there is an easy and safe strategy savvy investors can use to profit – even if you don’t know where the market is headed.

History Tends to Repeat Itself

Markets tend to react similarly to technical factors over time. Often, these signals give traders and investors clues as to what triggers an asset’s price to move up or down.

Market volume (the number of trades) and open interest (the number of open positions), for example, can influence markets. When markets become too overbought, they tend to correct and go down. When markets become too oversold, they tend to correct and go up.

That’s why watching technical indicators is so important. It keeps you one step ahead of the pack and puts you in a position to profit.

I didn’t realize the importance of technical indicators until I’d been trading for a number of years. That’s mainly because there’s much more information available today than there was three decades ago.

I relied almost exclusively on fundamental analysis. Understanding how markets operate fundamentally is one of the most effective indicators of an asset’s future price movement. A severe drought, for example, could affect this year’s grain harvest. Tighter grain supplies will likely lead to higher grain prices. Or a transportation snafu can affect an entire market because of late delivery.

But if there’s one thing I’ve learned throughout my 30-year career, it’s that…

Fundamentals Are Always Changing

When my opponent took out my pawn instead of my bishop, it completely altered the way I played the rest of the game.

The same is true in investing. A macro event like the debt crisis in Europe or the economic slowdown in China can drastically change underlying market fundamentals.

Even if the long-term fundamentals of a market are bullish, these macro events can create unexpected volatility in the short term that affects the direction of an asset’s price.

These events are inherently unpredictable.

So, as a trader, what can you do to profit from a big move you know is coming… whether it goes up or down?

Options.

With options you can make money if the market moves dramatically up or down. By using a long volatility position, you’re making a simple bet that the market will move with fury in either direction.

It involves simultaneously buying both a call and a put option. If the market moves significantly higher, the call option will make more money than the put option loses. The trade will be a winner.

If the market moves significantly lower, the put option will make more money than the call option loses. The trade will be a winner.

It’s a strategy that works. Here’s how…

Taking a Long Volatility Position in Crude Oil

The whole world watches crude oil prices. This commodity is a key benchmark that reflects the global economic climate. Crude is also produced in some of the most volatile countries in the world.

Fears of a double-dip recession in the U.S., debt problems in Europe and concerns that China is experiencing a slowdown in growth have caused crude oil prices to fall from a high of over $115 to a low of just under $75 a barrel this year.

A further deterioration in the global economic situation could cause prices to plummet further as demand for the commodity plummets. Oil traded as low as $32.50 in 2008 during the housing and banking crisis in the U.S.

On the other hand, heightened tensions between the major oil-producing countries could cause crude oil prices to skyrocket. Oil traded up to $147 in 2008.

Without a crystal ball, we can’t predict where oil prices will head over the coming months.

March crude oil futures traded on the NYMEX are currently priced at $87 a barrel. These futures have traded in a wide range between $100 and $75 over the past three months. Technical indicators are not telling us much at this point. Crude oil is neither overbought nor oversold, and it has very little momentum at current prices. Volatility, however, is high. This indicates that traders are expecting a big move, but they are not sure which way!

In this situation, a commodity options trader could purchase an at-the-money call and put option, called a long straddle. If you were to buy, say, a March 2012 NYMEX Crude Oil $87 straddle, it would cost around $17. Let’s take a look at an illustration of this long straddle on NYMEX crude oil futures:

How to Profit If Crude Oil Moves Up or Down

Long straddles make money if the market moves by more than the premium that is paid. That means this position becomes profitable if NYMEX crude oil is above $104 (87 + 17) or below $70 (87 – 17) by the expiration date.

Every dollar above $104 or below $70 would be a profit to you.

In options trading, using a long straddle when you don’t know where the market is headed, but you know it’s going somewhere, will make you a winner.

Happy Trade Hunting!

Andy Hecht

Crude Reverses Gains as China Raises Yield and Weather May Get Warmer

Crude oil reversed gains after failing to test 84 in NY session Monday. The February contract ended the day at 82.52, down -0.3%. Currently trading at 81.9, the decline accelerates as the central bank of China rolled out more tightening and weather forecasts suggested temperature will turn warmer later this week.

The People’s Bank of China (PBOC) sold 1-year bills at a yield of 1.8434% in open market operations. The yield has been staying at 1.7605% since August 2009. This may be a sign that China is trying to tighten the market more aggressively than expected. Last Thursday, PBOC offered RMB 60B worth of 3-month bills at 1.3684% in its weekly open-market operation, +4 bps higher than the rate kept since August. The move indicates that China would continue to guide market interest rates higher and absorb liquidity from the market through issuance of central bank notes.

Weather forecasts said that temperature will return to normal in eastern cities such as New York and Boston later this week. This news dampened bullishness as recent rally in energy price was driven by extremely cold weather in the Northern hemisphere. Traders believed the adverse weather condition should boost demand for energy.

Gold price settled at 1151.4, up +1%, after surging to as high as 1163 yesterday. A weak dollar may help push the yellow metal higher this week. Platinum extends its rally to 1602.5 in Asian session today. The benchmark outperformed others as the launch of the first US ETF spurred investment demand.

Last Friday, ETF Securities’ first US platinum and palladium ETFs started trading with strong volume. Initial allocation of the platinum and palladium ETFs were 9,969 oz and 9,996 oz, respectively, volume traded on the first day (reflecting both primary and secondary trade) reached 414,742 shares for platinum and 294,943 shares for palladium. Platinum holdings in the non-US ETFs also rose modestly by +158 oz to hit a fresh high, while palladium holdings fell by -5.5k oz to 1.155M oz.

Source: Oil N Gold

Gold and Oil Fall Sharply as Dubai Debt Fear Drives Investors Out of Risks

Commodities drop sharply around the world as markets sentiments are deeply pressured by risk of contagion effect from Dubai debt payment delay request which could trigger second wave in the credit crisis. Gold extended the decline from record high of 1195 and falls sharply to as low as 1130 level before recovering. Crude oil’s selloff also accelerates after taking out 75.57 support and reaches as low as 72.39 so far. Global stocks are under much pressure with Nikkei closed -3.22% low at 9081. European stocks are also sharply lower with FTSE 100 and DAX dropping more than -1% in initial trading.

Dubai World, the government investor company, sought to delay debt repayment until at least May. The news was a shock to confidence in the region and triggered much doubt in governmental support. More importantly, this will be a troubling development for international banks which are increasing dependent on Middle East markets as source of businesses. It’s believed that UK’s RBS, HSBC, Barclays, Lloyds and Stand Chartered are having large exposures in case of defaults.

Gold’s selloff today is a significant indication of short term profit taking after the multi-month power rally to new record high of 1195. 1200 level should be an important psychological level in near term and some correction should be seen to keep gold below 1200 for a while, with some risks of a break of 1100 level. But 1072 should provide strong support to contain the pull back.

Crude oil’s outlook is noticeably worse and 75.57 level will become a key near term resistance level to limit recovery. The choppy fall from 82.00 level would likely extend further towards 70 in near term at least. Meanwhile, deeper decline towards 60 could be seen if sell off in global stocks persist next week.

Sri Lanka as the Third Central Bank to Buy from IMF This Month, Gold Shines

Comex Gold advanced to as high as 1195 in Asian session after Sri Lanka purchased 10 metric tons of the IMF’s planned gold sales. According to the press release from the central bank of Sri Lanka, it has been acquiring Gold from the international market over the past several months ‘as a part of the diversification of the external assets portfolio’. The central bank believes the long-term stability of Sri Lanka’s external reserves will be strengthened as gold holdings will provide ‘a stable and long-term cushion against the impact of any potential volatility in major international currencies and financial instruments, in international financial markets’.

Sri Lanka was the third central bank in the world, as well as in Asia, to buy gold from the IMF this month. Earlier, the Reserve Bank of India and central bank of Mauritius purchased 200 metric tons and 2 metric tons, respectively, from the world lender.

Sale to Sri Lanka was announced shortly after Financial Chronicle’s report that India may want to buy the remaining of the IMF’s planned gold sales. This reinforced the notion that central bankers are seeking to diversify their reserves and gold is believed to be a good choice.

Apart from Asian economies, emerging markets such as Russia is also accumulating gold. Earlier this week, Bank Rossii, Russia’s central bank, reported that it increased its gold holdings by +2.6% to 19.5 metric tons in October so as to raise precious metals’ percentage in reserves.

According to Chairman Sergei Ignatiev, ‘the central bank has in the course of several years replenished its supply of gold with the goal of diversifying our gold and foreign currency reserves’.

Bank Rossii First Deputy Chairman Alexei Ulyukayev said on November 18 that the central bank is ready to buy all gold (30 metric tons) that Gokhran, the precious metals stockpile in Russia, has planned to sell this year.

Although the benchmark contract retreats to 1184 in European morning, the pullback is driven by USD’s recovery which is expected to be short-lived. In our view, minimal profit-taking despite US holiday indicates strong trading momentum.

Crude oil retreats to 77 in European morning after surging more than +2% yesterday. We believe the rally yesterday was mainly driven by slump in USD and strength in gold. Inventory report could definitely not support such a price hike. Crude inventory surged to 337.8 mmb, the highest in 4 weeks. Demand for oil products, while rising on weekly basis, remained depressed when compared with the same period last year. These spurred worries on the recovery outlook in energy market.

Source: Oil n Gold

Gold to Rally to 1200 as India May Buy More from IMF

Gold extends strength after consolidation after news said that Indian central bank may buy more gold. The December contract for the yellow metal rallies to 1180 and looks to march to 1200.

Indian newspaper the Financial Chronicle said that the Reserve Bank of India might buy the IMF’s remaining amount of gold. According to the newspaper, ‘RBI is an independent body and the government does not interfere in its affairs. It will get the gold if its bid is successful and at the price it has offered’. Although the news was not yet confirmed by India’s central bank governor, Duvvuri Subbarao, it thrilled gold bulls.

In early November, IMF announced the sales of 200 metric tons of gold to the Reserve Bank of India (RBI). The amount represented about 50% of the total sales volume of 403.3 metric tons that was approved by the Executive Board in September. About a week later, the world lender reported that sold another 2 metric tons, out of the rest of its planned gold sales of 403.3 metric tons, to the central bank Mauritius at market price. If the RBI makes the purchase, then India will become the world’s 8th largest holder of bullion in terms of volume, surpassing holdings in the Netherlands and Russia.

Further news pushing gold price higher was news that Vietnam has been granted quotas for the import of 10 metric tons of gold since lifting an import ban this month and 6.8 metric tons had already come in.

Central banks in the world, especially those in Asian regions, have strong demand for gold as they want to diversify their reserves from USD.

Crude oil recovers to 76.4 after sliding to as low as 75.78 in Asian session. Market’s focus is on the inventory report by the US Energy Department (EIA). Consensus forecast crude oil inventory rose +1.5 mmb while gasoline stockpile increased +0.3 mmb in the week ended November 20. For distillate, the stockpiles probably remained unchanged from the previous week.

Released after US market close on Tuesday, the industry-sponsored API reported an increase of +3.35 mmb of crude inventory to 336.4 mmb last week. The report was quite disappointing as the build was much higher than market expectation of addition of +1mmb. According to the report, gasoline inventory rose +1.17 mmb to 212.2 mmb and distillate stockpile drew -2.36 mmb to 166.9 mmb.

While the EIA’s report may echo API’s bearishness in oil market, oil trading should remain thin ahead of Thanksgiving holiday.

Comparison between API and EIA reports:

API collects stockpile information on a voluntary basis from operators of refineries, bulk terminals and pipelines. The government requires that reports be filed with the Energy Department (EIA)for its weekly survey.  Oil inventories from the API and EIA moved in the same direction for over 70% of the time, using data in the past 4 years.

Source: Bloomberg, API, EIA

Industry Estimates Showed Huge Decline in Crude Inventory

Crude oil price climbed higher yesterday after the American Petroleum Institute reported huge decline in crude inventory last week. The benchmark contract added +0.3% to close 79.14. In Asian session today, price continues to edge higher but upside momentum decreases as price moves closer to 80.

According to the industry-sponsored API, crude oil inventory drew -4.37 mmb to 333.1 mmb in the week ended November 13. The decline was significantly more market expectation of a drop of -2.2 mmb because attack of Hurricane Ida during the week caused shutdown of 43% of oil production facilities in the Gulf of Mexico. Gasoline stockpile was down -0.93 mmb, compared with consensus of -0.5 mmb, to 210.5 mmb as imports reduced. The disappointment came again from distillate stockpile which rose -0.51 mmb during the week as imports increased while demand slid.

The US Energy Department will deliver its weekly report in US session today. Crude inventory probably climbed +0.3 mmb. Gasoline and distillate stockpiles are anticipated to have dropped -0.025 mmb and -0.85 mmb, respectively.

Speculations on central bank buying and weakness in USD continue to drive investor crazy for gold. After mild consolidation Tuesday (closed at 1139.4, +0%), the yellow metal extends to a fresh record high at 1144.7 in Asian morning today.

The IMF’s sales of gold to the Reserve Bank of India and the central bank of Mauritius signaled more central banks will step up gold purchases. This phenomenon is positive for gold.

USD recovered modestly against major currencies as stock markets eased after US’ inflation, industrial production and housing data missed expectations. The dollar index gained +0.6% yesterday. The US Labor Department reported that PPI rose +0.3% mom while core PPI contracted -0.6% mom in October. Both readings were weaker than market expectations. Industrial production grew +0.1% mom in October while the market had anticipated a +0.4% increase. Worse still, September’s reading was revised down to +0.6%. NAHB housing market index stayed flat at 17 in November, contrary to consensus of an improvement to 19.

If economic data in the US continue to be disappointing, this should lead to weakness in USD in the long-term. Subdued inflationary pressure will allow the Fed to maintain its accommodative monetary policy for a long time.

Comparison between API and EIA reports:

API collects stockpile information on a voluntary basis from operators of refineries, bulk terminals and pipelines. The government requires that reports be filed with the Energy Department (EIA)for its weekly survey.  Oil inventories from the API and EIA moved in the same direction for over 70% of the time, using data in the past 4 years.

Source: Bloomberg, API, EIA

Crude Breaks Above 80 Again As Investors Speculate Pleasant Surprise from Energy Department

Crude oil rises above 80 (intra-day high: 80.23) in European morning. Investors are awaiting the EIA’s inventory report. As the market anticipates modest build in crude oil inventory, a surprising draw could trigger strong buying which may push price above the said intra-day high. However, we doubt if the rally will be sustainable as the inventory draw was to a large extend driven by hurricane Ida, rather than recovery in demand.

Gold extends rally to 1149.5 in European morning as the dollar resumes weakness. USD plummets -0.07% to 1.497 against the Euro ahead of US housing start and CPI data. Investors stay bearish on USD despite ECB President Trichet’s strong-dollar speech. Trichet said yesterday that a strong dollar is in the world’s best interest. Moreover, he denied the euro will be replacing USD as the dominant reserve currency. ‘The euro wasn’t created to compete with the dollar or to be a substitute to the dollar as a reserve currency…The ECB isn’t campaigning for the international use of the euro’.

US CPI probably rose +0.2% mom for the second consecutive month in October as driven by increase in energy prices. However, core CPI should have slowed to +0.1% mom in October from +0.2% a month ago. The soft reading in core CPI was due to weakness in the ‘rent and owners’ equivalent rent’ component. Housing starts are expected to have increased to 599 K units in October from 590K units a month ago.

The Bank of England minutes for November’s meeting revealed that while all members voted for maintaining the policy rate at 0.5%, there were splits regarding adjustment in the asset buying program. Out of the 9 MPC members, 7 favored extending the program by 25B pound. However, Chief Economist Spencer Dale preferred no change while David Miles favored a 40B-pound expansion. According to the minutes, Dale said that ‘further substantial injections of liquidity might result in unwarranted increases in some asset prices that could prove costly to rectify, complicating the task of meeting the inflation target in future’. Miles suggested a bigger expansion because it could ‘provide greater insurance against the downside risks to growth and inflation arising from constrained credit supply. That would maintain a similar rate of purchases as had been the case in the previous three months, once the intended break in the purchase program at the end of December was taken into account’.

Stocks in Europe advance as driven by rallies in commodity shares. In the UK, the FTSE 100 index climbs +0.4% to 5366. Germany’s DAX and France’s CAC 40 surge +0.7% and 0.6% to 5820 and 3583 respectively. Spurred by strength in oil price, BP and Shell adds +0.7% each. Mining shares, Xstrata and BHP Billiton, soar +3% and +2% respectively.

Earlier in Asian session, stocks plunged as investors concerned about capital-raising and share-issuance activities in banking and property sectors. While the MSCI Asia Pacific Index made little change in the day, Japan’s Nikkei 225 Stock Average slid -0.6% to 9677 after developer Tokyo Tatemono announced a plan to sell 45.6B yen in shares, the stock slumped -17%.

Source: Oil’n'Gold

Crude Oil Daily Technical Outlook

Nymex Crude Oil (CL)

Crude oil’s rally extends further today and the break of 73.16 resistance indicates that fall from 75.0 has completed at 65.05 already. The corrective three wave structure in turn argue that crude oil’s medium term rally is not completed at. Intraday bias is on the upside for retesting 75.0 first. Break will target 38.2% of 147.27 to 33.2 at 76.77 next. on the downside, below 72.18 minor support will turn intraday outlook neutral and bring consolidation first.

In the bigger picture, the break of 73.16 resistance favor the case that rise from 33.2 is still in progress for another high above 75.0. Nevertheless, strong resistance should be seen in 76.77/90.24 fibo resistance zone (38.2% and 50% retracement of 147.27 to 33.2) to conclude the medium term rise finally. On the downside, in case of pull back, break of 65.05 is needed to revive the case that crude oil has topped out. Otherwise, further rise is still in favor.

Nymex Crude Oil Continuous Contract 4 Hours Chart

Nymex Crude Oil Continuous Contract Daily Chart

Commodities Edge Higher on a Quiet Day

Crude oil rises to 72.15 in Asia Monday. However, trading volume is thin as Japan, US and Canada markets are closed on holidays today. Last Friday, Dow Jones Industrial Average climbed +4% to 9684.94 and S&P 500 rose +4.5% to 1071.49. Rallies in stock indices to 1-year high spurs interest in oil markets as investors anticipate recovery in energy market consumption.

Despite the improved sentiment, crude oil price will continue to gyrate within recent trading of 65-75 until concrete evidence of demand recovery is seen. Over the weekend, Kuwait’s oil minister Sheikh Ahmad al-Abdullah al-Sabah said that ‘oil prices between 60 and 80 are suitable for exporters and importers’. Judging from outcomes from recent OPEC meetings and comments from member countries, OPEC seems to be satisfied with current price level. The likelihood for further output cut is low in coming few months. In fact, rising spare capacity and rise in oil price have triggered some members to produce more than their quotas. The International Energy Agency estimated OPEC’s compliance has fallen to 62% in September, compared with 66% in August and over 80% in the first quarter.

Gold price has little change after plummeting -0.7% last Friday. Although currently recovers to 1051, the yellow metal may still have risk to decline on long liquidation and USD’s technical rebound. However, gold should resume its uptrend after consolidation. Global central banks’ diversification away from the dollar is expected to pressure USD further. At the same time, diversification would increase central bank’s purchase of gold.

Commitments of Traders

• Crude Oil: Net speculative long positions rebounded to 50006 contracts last week as oil price recovered. While staying below the peak of 62216 contracts 2 weeks ago, net longs in crude oil continued to hover around high level in 2009, suggesting traders were not much affected by stricter CFTC regulations
• Natural Gas: Net shorts contracted for the second consecutive week. Gas price has rebounded strongly in recent weeks but we worry that high gas price would delay demand recovery. Record high gas storage should continue pressure on the cash market which in turn forces the futures market to move lower
• Gold: Net speculative long positions reached record high of 239668 contracts. At long positions have become more stretched, we feel it more necessary for gold price to correct
• Silver: Net speculative long positions pulled back after rising for 7 weeks. Recent rally in silver have been simply an amplification of gold’s rise. Similar to gold, silver is prone to a correction before resuming the uptrend
• Platinum: Net long positions recovered to 17955 contracts

Source: Oil n Gold

Weekly Fundamental Outlook for Energies and Metals – Industry Experts Raised Demand Outlook on Oil

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