Monday, January 31, 2011

Global economy in general is moving towards higher growth

In this weekly update we take a look at some of the themes that drove
commodity sectors in different directions during January.

The global economy in general is moving towards higher growth with the
IMF this week raising its global economic growth forecast to 4.4 from
4.2 percent.

What has also become very clear is that inflation, caused by higher
energy and food prices, is on the rise and looks set to increase
further over the coming months. The low interest environments in
recovering economies, especially the U.S. has supported its stock
markets but also assisted some of the price rises seen in commodities.

Stock markets in BRIC nations, minus Russia, showed the worst return
among equity markets during January.
Higher inflation and worries about further tightening, especially in
China saw these markets perform poorly. How China will cope with
additional economic tightening remains one of the important themes
when looking at future commodity market performance.

In Europe the sovereign debt fears were eased somewhat with Italy,
Spain and Portugal managing to issue debt. This was followed by a
successful auction of the first European bail out bond which was
heavily oversubscribed.
The euro recovered from its early January low while the dollar lost
nearly five percent against a basket of currencies.

In commodities the speculative length of futures positions as measured
by the CFTC has seen a slight reduction during the month primarily
from a reduction in energy and precious metals.

The Reuters Jeffries CRB index is almost flat on the month but
performances differs with soft commodities like cotton, cocoa and
sugar performing strongly while precious metals have lost their shine
a bit.

Cotton jumped to a record amid a global shortage of the fiber with new
production from the southern hemisphere not expected to reach the
market until April. Surging demand from Chinese cotton mills on the
back of global economic recovery has left growers struggling to meet
demand. Prices have now more than doubled over the past year as
increased demand has failed to be met with adverse weather reducing
global crops.

Cocoa had the strongest rally in more than three years, reaching a one
year high, on worries about supply disruptions from the Ivory Coast,
the world's largest producer. The President-elect ordered to halt
shipments for a month in order to cut funds for the incumbent
president who refuses to accept defeat in the recently held election.
With more than 80 percent of shippers respecting the order stocks are
barred from reaching the global market adding upside pressure on

The price of spot month lean hogs reached the highest prices in at
least 24 years after the worst outbreak of foot and mouth disease in
Asia for at least 50 years has put upside pressure on US exports and
prices. South Korea alone has been forced to remove about 25 percent
of the breeding herd due to the disease.

Higher food prices have been a contributing factor to the recent wave
of social unrest across North Africa and the Middle East. This has
subsequently driven governments across the developing world to
stockpile food staples like wheat, rice and sugar in an attempt to
contain social unrest and dampen panic buying and inflation. The price
of wheat rallied to a near three year high; surpassing the levels seen
during the Russian drought last summer, after several countries
announced extraordinary purchases. After the weather related slump in
production last year the U.S. currently hold most of the quality wheat
required and this is aiding prices and exports.

Turning to the energy sector the thing that have had many puzzled
recently has been the incredible widening of the price spread between
WTI crude and North Sea Brent. During January we have seen Brent
outperform WTI by more than ten percent and in the process WTI's
status as a global benchmark for oil has weakened.

Looking at some of the other international oil indices like Oman
Crude, African Bonny Light and Light Louisiana Sweet it is pretty
clear that spot WTI has dislocated and is cheap on a relative basis.
This cheapness is being caused by the supply overhang at Cushing,
Oklahoma, the landlocked delivery hub for WTI crude. Currently the
market is discounting this problem to be solved in 2012 when a new
pipeline to the Gulf of Mexico will ensure that production from Canada
can reach the coast and be exported instead of being stored at

With spring reaching the northern hemisphere we should see demand for
products decrease and refineries going into maintenance. This will add
additional pressure on crude storage facilities and with Cushing
already holding a near record of 37.7 million barrels spot month WTI
crude could find it hard to progress in the near term. This is also
reflected in the spread between spot and delivery in six months time.
Since December this spread has widened from 80 cents to 850 cents
making investments in ETFs that track spot crude increasingly
unprofitable due to the monthly cost of rolling.

The International Energy Agency predicts that 2011 demand will rise by
1.4 million b/d to 89.1 million after having risen by 2.75 million b/d
in 2010, the strongest growth in 30 years. At the same time they
warned that high crude prices could put a brake on the economic
recovery. OPEC despite no official statement seems to have responded
and is now unilaterally raising output. They do not want prices to
rise too high, too quickly and with signs of synchronized economic
growth they will have to use some of its spare capacity, currently
expected to be around 5 million barrels per day.

Gold and silver sits at the bottom of the performance table and are
heading for the first monthly loss in six months and the longest
losing streak in almost a year. Investors have been scaling back
positions during January as higher equity prices and reduced sovereign
risk in Europe has left other markets looking more attractive. Gold
rallied strongly during 2010 on the back of increased inflation fear
and now that it has become a fact profit taking has set in indicating
a belief that this was somewhat priced in already.

Going forward it is very important to keep a close eye on investments
flows in and out of ETFs as many large hedge funds and asset managers
are positioned in gold and silver through these products. During
January investments via gold ETFs dropped by 77 tons to 2,047 tons and
some hedging and liquidation of positions has been the driver. The 200
day moving average on gold is now getting close at 1,285 and could be
the line in the sand just like July last year or be the trigger for
additional position should it give way.


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