Commodities Attempt To Recover As US, China Data Lends Support

Commodities, apart from precious metals, are tentatively trying to recover following the onslaught over the past week. An unexpected sharp downward revision to US first quarter growth yesterday combined with several dovish comments from US Federal Reserve central bankers has left the market with the impression that the timeline with regard to end-of-asset purchases may be somewhat longer than the market had been led to believe. Elsewhere in China, the fear of a credit crunch has somewhat eased with short-term lending rates falling, following soothing comments from the Central Bank. In Europe, the European Union (EU) struck an agreement on how to deal with failed banks helping to halt the dollar rally. The euro subsequently moved back above 1.3000 lending support to commodities.

Sentiment however remains fragile and momentum across most commodities is still pointing lower with only a few agriculture commodities going against the prevailing trend.

Oil prices are higher for a fourth day but with Brent crude oil as an example, have still only recovered less than half of what was lost during the two-day sell-off last week. However subdued the price recovery so far has been, it nevertheless indicates that traders are re-focusing on those factors that drove prices higher before last week's abrupt sell-off. Demand for oil is expected to pick-up as favourable refinery margins have led to a pick-up in demand from these following maintenance. Seasonal demand for air-conditioning (Saudi Arabia and Japan to mention two of the majors) is also expected to be strong over the coming months. Supply is also in focus as geopolitical tensions in the Middle East remain a fear factor which has the ability to quickly add a few dollars to the price.

The biggest risk to the downside comes from the investment community itself as hedge funds are holding a relatively large net-long position in both crude oils which so far has failed to perform and any renewed weakness carries the risk of long liquidation which could extend the recent lows in Brent crude and WTI crude by five dollars. The 200-week average on Brent crude, currently at 99.40, has offered support on several occasions since April and that level is currently being viewed as the line that needs to hold in order to avoid that fear of long liquidation.

Gold yesterday sank to a three-year low, down by more than a quarter so far this year and on track to show the worst quarterly performance since the collapse of Bretton Woods in 1971 as mentioned by the FT yesterday. Flows from Exchange Traded Products on Monday were the biggest since April 15 and the fourth largest this year indicating that the great unravelling process is ongoing. The speculative positioning in futures for this past week will be known on Friday after the close but there is no doubt that the net-long position would have shrunk even further.

As the price drops, the talk of mining companies' production-cost and break-even levels rises. Mining companies have seen profitability greatly reduced with the price collapse. This helps to explain why an index of leading mining companies is down by almost twice as much as the underlying price of gold. While the scramble to reduce exposure continues, a move below mining companies' break-even levels will not have a great impact but if it becomes a prolonged event, supply could begin to suffer. In turn, that will help bring some balance back to the market. Technically, many still view 1,150 as a potential downside target while the first level of major resistance can be found in a 1270 to 1275 band.

Crop markets are currently waiting for a government report on Friday which will shed some light on what acreage has been allocated to the key crops and also to what extent the old crop of corn and soybeans in particular has been depleted. The combination of multi-year low stocks of those two key crops together with bullish expectations about the outcome of the coming harvest has seen the price differentials between the old and new crop rise to 20 percent on corn and 15 percent on soybeans.