Market sentiment was marked by risk averse and flight for save haven last week. The issue in Dubai World once again shook market confidence. Last Tuesday, a Dubai government official said the 6-month period, scheduled on November 25, for debt restructuring is not enough. Abdulrahman al-Saleh, head of the Dubai finance department, told reporters that 'the period of 6 months would be too short for a full restructuring. The 6-month period would focus on the creditors, the contractors and so on'.

In Europe, things were not better. Fitch Ratings' downgrade of Greece's credit and Moody's warning that deteriorating public finances in the US and the UK may test the nations' Aaa ratings. Fitch Ratings cut Greece's rating to BBB+, the 3rd lowest investment grade, following S&P's announcement that it may downgrade the nation's rating from A-. In the accompanying statement, Fitch said that 'the downgrade reflects concerns over the medium-term outlook for public finances given the weak credibility of fiscal institutions and the policy framework in Greece... The lack of substantive structural policy measures reduces confidence that medium term consolidation efforts will be aggressive enough to ensure public debt ratios are stabilized and then reduced over the next three to five years'. In fact, should Greece default, its harm on the world's financial stability would be far more than caused by Dubai as many banks, especially those in Europe, have exposure in Greece'.

A day later (Wednesday), S&P lowered Spain' debt outlook to 'negative' from 'stable' as the country will have 'more pronounced and persistent deterioration' in its budget and a 'more prolonged period of economic weakness' that what was anticipated in beginning of the year.

Countries possessing the highest credit rankings should also beware. According to Moody's, the US and UK have 'resilient' Aaa ratings as the countries' public finances are deteriorating considerable and may 'test the Aaa boundaries'. However, the governments still can display 'an adequate reaction capacity to rise to the challenge and rebound'.

These news triggered panic selling and investors moved their capitals to USD. The dollar index gained +0.9% last week. The index slumped -5.8% this year as the market turned optimistic about global economic outlook and lured for risky investment. Moreover, the Fed's low interest rate policy has also pressured the greenback. However, speculations about an earlier-than-expected rate hike loomed after the strong employment released in early December.

Strength in the dollar weighed on the commodity market. The CRB lost -2.9% to 270.86 last week.

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Crude Oil

Disappointedly, WTI crude oil failed to record gain Friday despite rebound in stock markets. The benchmark contract has fallen for 8 consecutive trading days since December 2 and lost -7.4% to settle at 69.87 on weekly basis. The closing price was also the lowest since October 7.

The major factor dragging price down was strength in USD. The dollar index touched a 1.5-month high at 76.726 Friday and ended the day with +0.9% gain. Against individual currencies, the greenback rose +1.7% and +1.3% against the euro and the pound. The New Zealand was among the very few currencies than outshone USD. The Kiwi surged +1.2% last week as the RBNZ signaled that it may raise the policy rate earlier than previously expected.

Apart from broad-based impact by USD's strength, oil-specific fundamentals were damaging prices, too. Although crude inventory declined more than market expectations, huge builds in gasoline and distillate stockpiles fueled worries about demand outlook.

The -3.8 mmb decline in crude inventory was mainly due to draws in the Gulf Coast. However, the huge increase in the Midwest highlighted by Cushing stockbuilds suggested spreads between WTI and Brent crude price will continue widening in coming weeks.

The more disappointing news came from surge in gasoline and distillate stockpiles. Demands remained weak with 4-week average of total US fuel demand dropping -3% yoy to 18.5mmb last week.

The severe decline in crude oil price has been driven by slow demand recovery in developed economies. In fact, consumption in emerging countries has been robust. For instance, the Chinese government reported strong refinery output in November. Refining volume climbed +21% yoy to 33.4M metric tons during the month. Gasoline surged +11% yoy to 6.33M tons while diesel output climbed +14% to 12.4M metric tons. Kerosene production soared +33% to 1.3M tons but fuel oil production slid -4.6% to 1.58M tons. Apart from cold winter, oil companies also lifted processing capacity after the government adjusted the oil pricing mechanism last December. The new scheme takes into account the cost of crude oil and ensures refinery profits.

Weakening in WTI time-spread has accelerated since December. Over the past months, investors turned more optimistic about global economic outlook after receiving much upbeat data. This made them anticipate rapid recovery in oil demand. Therefore, long-term oil contract had rallied to over 90/bbl. However, subsequent inventory reports indicated demand from advanced economies, as led by the US, has remained dismal. Together with Dubai's news and downgrades of Greece and Spain, deep correction in crude oil price was resulted.

On the supply side, oil production in both OPEC and non-OPEC countries should be sufficient to meet growth in demand in coming years. Recently, news suggested that the 2 OPEC laggards, Nigeria and Iraq, is going to catch with their counterparts in production.

Since 2006, oil facilities in Nigeria has been facing attacks by armed groups (of which MEND is the biggest) who pledged to fight for more local control of the oil wealth of the Niger River delta. Assaults on oil infrastructure have cut more than -25% of the nation crude output. In July 2009, Nigeria produced only 1.67M bpd of crude oil, according to OPEC's report. Prior to the escalation of violent attacks, the nation's production was around 2.5- 2.6M bpd.

However, in October, MEND announced an 'indefinite cease-fire' after negotiation between President Umaru Yar'Adua and the group's leader, Henry Okah. Industry surveys showed that production in November rebounded quickly to 2M bpd. The government estimated oil production to reach an average of 2.088M bpd next year and 2.275M bpd in 2011. It also hopes to raise production to 4M bpd in the next decade.

The second round of auction in Iraq's oil field ended Saturday and awarded 7 of the oil fields offered for development, representing 28% of the country's crude assets. The largest one was awarded to OAO Lukoil and partner Statoil ASA, the consortium won rights to develop the second phase of Iraq's 'super giant' West Qurna crude deposit. The government aims to boost output to more than 12 million barrels a day over the next 6 years. Oil production in Iraq averaged at 2.341M bpd in 2008 while the level is expected to be similar this year. The most prominent risk to the success of oil field development remains to be political uncertainty and instability.

Natural Gas

Although Friday's selloff pared part of the gain made after release of better-than-expected storage report, the benchmark contract still managed to gain +12.6% over the week.

According to the US Energy Department, gas inventory declined -64 bcf, compared with consensus of a -45 bcf draw, to 3773 bcf in the week ended December 4. It's believed that unexpected cold weather in Northern hemisphere has boosted demand. In coming week, the temperature in the US will remain 'below-normal' and this should help lowering gas storage in the near-term.

However, non-weather demand continues to be stagnant and this should hinder strength in gas price in the medium- to long -term. Another overhang is expansion in drilling activities. According to Baker Hughes, the number of gas rigs climbed +9 units this week to 757 units as producers rode on the price rally.

After plummeting to 7-year low of 665 units in July, the number of rigs has surged by almost 100 units since then. Although it remained -53% below the peak of 1606 units, analysts believe further decline in rig counts is good for the demand/supply outlook. Government data showed that gross gas output was still +11% above the same period last year in September.

Precious Metal

Gold for February recovered last Friday as USD pared gains. Settling at 1119.9, the benchmark contract reduced the weekly decline to -4.2%. Price above 1000 looks to be a good bargain to accumulate gold.

Undoubtedly, the selloff after reaching a record at 1127.5 on December 3 was driven by profit-taking and strong rebound in USD. In early September, the yellow metal's rally above 1000 was coincident with renewed decline in the dollar as the greenback's status as the world's dominant currency was once again in question.

Now that investors park their capital to USD amid concerns over sovereignty risk inevitably hurt the yellow metal. While we have emphasized that it's not a must for USD and gold to move inversely and there was occasions that both of them moved in the same direction. The current situation is rather different as the yellow metal had rallied rigorously and made fresh records over the past few months. Long liquidations should have pushed price lower.
That said, we are not very worried about gold's long-term outlook. On the demand side, jewelry buyers should accumulate gold when price falls. This should help supporting gold price. On supply side, central banks have sold insignificant amount of gold and are expected to turn from net gold sellers to net gold buyers next year. Moreover, demand from emerging countries is still robust. Central banks in India, Mauritius and Sri Lanka have absorbed most of the IMF's planned gold sales of a total of 403.3 metric tons in November.

The world is now eyeing on China which is the most prospective buyer of the rest of IMF gold. An official report in April showed that the country increased its gold reserves by +76% to 1054 metric tons since 2003. As China's gold holdings represent less 2% of its reserves, it's justifiable for the country to increase purchase.

However, China is the world's largest producer of gold. It has the ability to buy its own gold and does not need to expose to price risk like others. For example, the IMF said the India paid at 'market price' for its gold purchase. As gold price rises, China will be less interested in IMF gold.

Base Metals

The best performer was aluminum which gained +5.9% last week. LME inventory has dropped recently while Chinese imports remained strong. Imports of unwrought aluminum increased +39% m/m and 122% y/y in November despite strong domestic production, +8% m/m, suggested domestic demand is strong.

Upside surprises were also seen in other base metals. For instance, imports of unwrought copper surged +10% m/m and +34% y/y. the increase was also came along with increase in domestic production and lack of arbitrage opportunities (SHFE/LME differential was negative). This also indicated continued strength in domestic demand.

Considering the base metal complex as a whole, erratic and directionless trading will continue until we have got more solid evidence that inventories are declining.

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