Monday, January 17, 2011

Commodity weekly: Focus shifts to commodity driven inflation fears

Inflation attracting attention during a week where stocks and
commodities rose as euro zone debt fears receded after successful bond
auctions from some of the zones most economically fragile members. The
four percent surge of the Euro versus the dollar which up until
Thursday mostly looked like a short covering rally gathered additional
speed when Jean Claude Trichet, the ECB president, got tough on
inflation and thereby increased the chance of a rate rise earlier than
the market may have been anticipating. European inflation rose to 2.2
percent in December, the fastest pace since 2008 and is now above the
ECBs ceiling of two percent.

The leading Chinese stock market index erased the gains for the year
ahead of an announcement from the People's Bank of China that they
raised bank reserve requirements further. This will be one of the
themes that could dampen the expectations for higher commodity prices
in 2011. Consumer prices rose to 5.1 percent in November, the most
since 2008, on surging food costs.

Commodities, of which many had seen retracements during the first week
of January, got back in gear with the Reuters Jeffries CRB index
racing ahead and almost reaching fifty percent retracement of the 2008
to 2009 sell off. Strong rallies among agricultural and energy
products left the index 2.3 percent higher at the time of writing.

Energy prices recovered from the bout of selling during the first week
of January on the back of various supply disruptions. The report into
the leak in the Gulf of Mexico last year could herald a new and more
expensive era for offshore drilling with some projects being delayed
as a consequence thereby reducing supplies into the US market.

European Brent crude look set to be the first to test the 100 dollar
level as it continues to trade at a steep premium over WTI crude. This
week it touched 98.85 per barrel with the premium over March WTI
rising to six dollars. Supply disruptions and cold weather in Europe
combined with high inventory levels at Cushing, the delivery hub for
WTI crude, has caused this dramatic widening.

Discussions are ongoing whether the price of Brent crude is a better
reflection of the current global demand situation with WTI crudes
status as the global benchmark increasingly being threatened. What
seems to be clear is that global demand rose strongly during the last
quarter of 2010 and projections for growth in 2011 is still pointing
towards a global increase in demand. OPEC with their excess capacity
is in no hurry to turn up the tap and holds the key as to how the
price will behave over the coming months.

The ninety dollar level continues to be the pivot for WTI crude with
the recent highs at 92.60 providing resistance while support can be
found at the December and January lows at 87.10.

Silver and gold has struggled to gain some traction during the last
couple of weeks. Reduced sovereign debt concerns, stock market gains
and a shifting focus towards cyclical commodities such as energy and
base metals have removed some of the strong support seen during the
previous six months. The speculative long position in both metals has
seen a continued reduction over the past three months while
investments through ETFs have also seen a reduction albeit a small

Silver has underperformed gold by three percent recently and is
currently stuck in a 28 to 30 dollar range while gold is trading in a
range between 1,350 and 1,400. A break below those two lows increases
the risk for additional position squaring.

The world agricultural supply and demand report from the USDA on
Wednesday triggered another round of price rises for corn, soybeans
and cotton as global stock levels continues to dwindle. Stocks to use
ratios fell to a fifteen year low for corn and a thirty year low for

Strong demand for ethanol now take up nearly 40 percent of the US corn
production and it is estimated that this demand will only begin to
suffer should corn prices move above USD 8 per bushel, some 25% higher
than current levels. Strong expected demand for soybean oil will leave
soybeans stocks at the lowest levels for thirty years and rationing or
higher prices to curb demand could be the result.

From a food security point of view the report did have some positive
news. Rice and wheat are two of the most important cereals with rice
being the stable diet for billions of people in Asia. The USDA
increased its harvest forecast for rice and cut the demand outlook
while the wheat market is amply supplied. Wheat as subsequence has
underperformed corn by more than five percent since year end, a trend
that could continue over the coming months.

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