The Hindu Business Line : Tide may be turning for commodities; metals vulnerable

The worst may not be over for the world drowning in the deep sorrow of financial crisis, market meltdown and economic recession; but the overall economic sentiment is seen turning positive following a series of actions by various governments in recent months and particularly after the deliberations at the G-20 summit in London last week. Is the tide turning at last?

After a disastrous last quarter of 2008, the quarter that just went by witnessed an emergence of divergent trends in the commodities marketplace. Global equity markets, commodity prices and commodity country exchange rates have all shot up since mid-February. There is hope that industrial production will bottom globally in the first half of 2009 before recovering in the second half.

China is seen as the main driver of this recovery. Within the commodity complex, the divergence of trends is apparent. Crude has been continually firming because of tightening fundamentals. Some base metals such as copper have performed exceedingly well. Gold, the eternal favourite of the punters, has stood the test of time to reaffirm its safe haven status.

Belief is gaining ground that the extreme urge to reduce risk exposure seen in the second half of last year has now given way to some kind of a more nuanced judgment of supply-demand fundamentals. Importantly, risk appetite is returning slowly but surely, with net length as a percentage of total open interest in the US commodity futures market rising to eight per cent recently, the highest in six months.

At once ironic and interesting, market-men are reading economic data rather positively although the actual message may be negative. Take the US unemployment rate which increased to 8.5 per cent in March, up from 8.1 per cent in February and now is at the highest level since 1983. The result was in line with market expectations and was generally positively received as it allayed market fears of an even worse result. There were 6.63 lakh jobs lost for the month and there are now 13.2 million unemployed people in the US.

It should surprise none if the current quarter (April-June) has in store some more negative news before one sees light at the end of the tunnel. Commodity markets are prone to be volatile in the next three months with data-flows emitting mixed signals. Non-fundamental factors are likely to continue to impact prices as never before.

Gold

With improvement in the equity market, upbeat macro-economic information and definite easing of uncertainty, gold has come under pressure. Prices dipped below the $900 an ounce level as some speculators exited the market. To be sure, investor interest continues to remain buoyant. Inflows into physically-backed exchange traded products have remained strong during January-March.

Gold prices came under pressure following the G20 discussions over the IMF selling its gold holdings to fund development programmes. However, it was clarified that that there would be no additional sale of gold over and above what was already committed. Last week’s move below $900/oz should be seen as a short-term correction.

In London, on Friday, the PM Fix was $905.00/oz, up from $897.75/oz the previous day. Silver behaved slightly differently with Friday AM Fix at $12.86/oz versus previous days $12.88/oz.

Despite recent volatility of the US dollar, the currency is widely expected to weaken (against the euro) gradually during the year and an inflationary environment is likely to build as months pass by. This should prove positive for the gold market.

However, physical demand is at threat. Major importers such as India have had no imports during February and March because of the adverse effect of high prices on physical demand. There is definite consumer resistance at higher price levels. If and when the world returns to the growth path, the yellow metal may lose some of its sheen as investors will have wider options to put their money in.

Although the market remained above 882/87 support, last week was bearish for gold. According to technical analysts, while above this zone, one cannot rule out the possibility of the metal testing 1,000 later this quarter, a break of 882 would mean a severe challenge and gold may slide by another $20-40. Near-term resistance is at 933. In the medium-term expect choppy activity on way to test four-digit price.

Base metals

The complex continued to rally strongly last Friday as optimism remained dominant following Thursdays G-20 meeting and consequent global stimulus announcement. The market sentiment shows signs of improving, aided by some stock drawdowns of copper and aluminium. Copper closed at $4,275 a tonne, its highest close since October 30, 2008.

However, the price rally could be short-lived as fundamentals begin to catch up and the euphoria of the sentiment evaporates. Actual demand is still a matter of concern. In case of copper, the market fundamentals are less positive than they were a few weeks ago and the rally is being sustained by macro-economic factors. A pullback to the low $3,000s looks more likely.

In case of aluminium, although the risk of price gains on short-covering have increased, poor fundamentals do not support a sustained price performance.

While zinc looks to have the least downside, lead looks vulnerable to a sharp pullback. Nickel is likely to trade range-bound because of weak stainless steel demand.

According to technical analysts, after a strong week, the focus for copper remains higher. The next target is at 4,366. One can expect 4,100 to hold firm this week as the metal builds value at higher levels.

Crude

Clearly, crude market has moved up to a higher trading range as the change in sentiment is positive. Voluntary OPEC output cuts and involuntary non-OPEC production reductions have more than offset the steep fall in demand. Although global demand still remains weak, it is not getting worse. A further tightening of the oil market balances is seen imminent.

With sentiment turning more constructive and fundamentals improving, there seems to be upside price potential. In Q2, prices may average $50 with the market moving 10 per cent on either side, but with a bias towards the upper end.

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