Gold and Silver Glitter; Natural Gas Dogged By Oversupply

Looking at year-to-date returns across different asset classes one would almost think that we were looking at a 6 month review, not just one month. A very strong performance has been seen across many different asset classes and some have had the strongest start for decades. The negative sentiment that prevailed across financial markets towards the end of 2011 was all forgotten during January and investors, of which many had applied defensive strategies, were forced to chase the market (higher).

Stock markets across the world rallied, especially emerging markets recovered strongly with the MSCI Emerging market returning 11.4%. The dollar, at least temporarily, ran out of favour after having become overbought, especially against the Euro and some EM currencies. Cyclical stocks were the top performing sector during January and this was also reflected in commodities with the table below showing how commodity returns in January were all about metals.Precious and industrial metals were flying during January and many investors in the latter got caught out and short positions were reversed into longs thereby giving the rally an extra boost. The agriculture sector performance was flat, while the energy sector surprisingly had a negative month despite the current geo-political wrangling. Exceptional low interest in the US combined with quantitative easing in Europe has brought back memories of the late 2010 commodity rally that was triggered by the second round of quantitative easing in the U.S that year.

Looking at individual commodities, it is therefore not a surprise to find silver, gold and copper among the top five performing commodities while the bottom once again is occupied by natural gas which continues to be dogged by oversupply. WTI crude also fell and the discount to Brent crude widening dramatically once again due to different supply outlook in the US compared with the rest of the world.The dollar has weakened from its mid-January high, thereby helping commodities in general. During the correction however hedge funds have continued to add to record long positions, especially against the euro, thereby showing a strong conviction that it will soon strengthen again. Alternatively one could argue that further dollar weakness eventually could trigger stop loss selling of dollars further assisting the performance among commodities.

Silver has been the star performer during January, not least helped by the fact it began the year from relatively depressed levels, having been very much out of favour during the latter part of 2011. On a relative basis to gold it has outperformed quite strongly, with the ratio once again approaching 50 ounce of silver to 1 ounce of gold from recent high of 57.4. Technically it will find resistance towards 36.50 dollars per ounce which is the top of its current range as defined by the trend-line from the 2011 high. Support is the bottom of its recent consolidation area at 33 dollars.

Gold prices rose this week on course for a fifth straight week of gains, with investors having regained some of the confidence that was lost during the recent sell off. The rally gathered pace after the surprise announcement by the U.S. Federal Reserve that it was likely to keep interest rates at ultra-low levels at least one year longer than the market had previously expected. This combined with ECB pumping billions of euros into the financial system have been the kick that gold needed to resume its rally. Technically it has now moved into oversold territory which raises the risk of a pull back or at least some consolidation. The current trading channel offers resistance at 1,770 dollars per ounce while support can be found at 1,735 ahead of 1,700.Hedge funds began 2011 holding a negative view on copper as the economic outlook was marred by uncertainty, given the European debt crisis and the risk of a hard landing in China, the world’s largest consumer. A small change to that outlook, combined with an improved US economic data, triggered a strong turnaround with copper rallying one fifth from the December low in the process recouping half of what was lost during the 2011 sell-off. This has now raised the question of whether the market has run ahead of itself, and with positions having been readjusted further positive news from the global economy is required, something that could be illusive at this stage.

The price of WTI crude oil has been drifting lower recently with traders increasingly unsure about the next move. Signs that global consumption continues to slow if not outright contracting has been offset by the risk of a price spike on the back of several geo-political risks, especially the standoff between Iran and Europe over its nuclear intentions.

Hedge funds have continued to increase their long exposure to WTI crude, currently at 248 million barrels, during a period where the price has actually fallen. This has increased the risk of long liquidation, something that was seen this week when additional news about falling US demand was seen.  According to the US Energy Information Agency, demand for oil in America has now fallen to about 18 million barrels per day, especially on the back of a sharp drop in gasoline consumption.

This has put the price of WTI crude under relative more pressure than Brent crude with the discount widening to 16 dollars, the highest level in almost six month. This renewed dislocation is also an expression of the geopolitical risk premium which primarily benefits Brent crude given its current status as a global benchmark. Also combined with the tightness in Europe which has kept demand for Brent crude high, especially with several countries having to scout for new suppliers ahead of the July embargo against Iranian oil.
Technically Brent crude is stuck mid-range between 115 and 109 while WTI crude is once again testing support due to the above mentioned underperformance. A break below 95 dollar now carries the risk of aggressive long liquidation which could see the price move fairly swiftly back towards 90 dollars.