The commodity sector performed very well in 2009 with the Reuters/ Jefferies CRB Index rising +23% on annual basis. Central banks worldwide reduced policy rates to record low levels and implemented stimulus programs to combat the worst recession since WWII. While it's yet to say the world has exited recession, improvements in economic data have showed that recovery is underway.


Crude Oil

Geopolitical tension, inventory decline, cold weather and strong macro data firmed oil price in the last week of 2009 and paved the way for a good start in 2010. The February contract touched 80 and closed at 79.36 Thursday, up 1.7% on weekly basis. Crude oil experienced a volatile 2009 with price diving to as low as 32.7 in January and then rallying to 82 in October. The annual gain of 78% has marked the best performance since 1999.
Both industry-specific and macro data were supportive for crude oil last week. Crude inventory drew -1.54 mmb to 326 mmb in the week ended December 25. This 4th-consecutive weekly decline has brought the stockpile to the lowest level since January. Distillate stockpile also dipped for the 3rd week, by -2.06 mmb, to 159.3 mmb while gasoline stockpile drew -0.37 mmb to 216 mmb.

Economic indicators released over the week indicated recovery in underway. Initial jobless claims dropped to 432K, the lowest level since 2008, (consensus: 455 K) in the week ended December 26 from 452K in the prior week. Moreover, continuing claims also slid -57K. On manufacturing and sentiment fronts, Chicago PMI rose to 60 in December from 56.1 a month ago while consumer confidence improved to 52.9 from 49.5. The data fueled optimism about US' growth in 2010.

Geopolitical issues have been important factors determining oil prices. Conflict in Iran intensified and spurred worries about the nation's oil exports. Since the protest, regarding the disputed Presidential re-election in June, began on December 27 in Tehran, the Iranian government has detained about 1000 people. At the same time, Iran accuses Western countries of spurring the demonstrations. Oil prices usually get supported when turmoil occurs, especially in the Middle East as the region in rich in oil. Iran, the world's second largest oil producer, may threaten to suspend oil exports if the tension escalates.

While correction may be seen in early January, we are cautiously optimistic on crude oil's outlook in 2010.

As global economic recovery gains pace, demand for oil should also turnaround. While the market has focused on emerging markets, OECD economies, besides the US, have shown signs of demand recovery since late-2009. Decline in Japanese demand moderated in October. Consumption dropped -0.064M bpd yoy during the month, compared with an accumulated -0.443M bpd drop since the beginning of the year. In the UK, demand also surged +6.8% yoy in August.

Certainly, the growth engine was and will still be in emerging markets, especially China. Chinese oil demand recorded the biggest increase, by +18.6% yoy, to 8.184M bpd in November. When compared with 2007, the increase was still at a prominent +16.8%. Over the past 3 months, demand in China has recorded double-digit growth as driven by robust refinery runs. We believe further upside risks will be seen in 2010.

On the supply side, strong production growth in 2008 and 2009 may not repeat in 2010.although several new projects may start next year, total addition in capacity will likely be less than that in the previous 2 years. Moreover, as many oil producing countries are still face budget concerns, capex investment may shrink.

Concerning OPEC supply, we do not expect much change from current level. In the second half of 2008, the OPEC reduced output quotas by 4.2M bpd to 24.845M bpd to rescue oil price from its worst slump. Compliance was as high as 80% earlier in 2009 but then fell to around 60% later in the year as oil price rebounds. At the meeting in December 2009, the organization controlling the world' 40% of oil announced to keep production quotas unchanged but pledged stricter compliance. While oil price should go higher in 2009, the rise will be gradual and therefore, it's unlikely for the OPEC to announce dramatic change in its output policy.




Natural Gas

After surging to 6.038, the highest level in 2009, gas price slid and closed at 5.572 Thursday as decline in US gas storage was less than expected. According to the US Energy Department, natural gas inventory dropped -124 bcf, compared with consensus of a -145 bcf fall, to 3276 bcf in the week ended December 25.Natural gas slumped in the first 2/3 of 2009 amid weak demand and sky-high storage level. Cold winter arrived late this year and inventory did not start declining until December. Strong recovery of +15% in December help recover most losses and price was largely flat on annual basis.

It's widely known that gas demand was crippled as industrial activities contracted rapidly in 2009. The US Energy Department expects total natural gas consumption will decrease by -1.9% in 2009 and by an additional -0.4% in 2010. Demand decline in the industrial sector as well as the residential and commercial sectors were significant. However, they were partly offset by growth in the electric power sector. At the same time, displacement of coal also helped alleviating pressured from the lack of demand. Low natural gas prices relative to coal caused substantial switching to natural gas for baseload electric power generation throughout most of 2009. This advantage may be lost as natural gas price goes higher in 2010.

The market worried about heavy selloff in gas price as gas inventory was about the break record high in September. As storage approaches full capacity, producers will need to dispose the excessive gas and this is negative for price. Gas storage surpassed previous record high at 3545 bcf on September 25 and the level had been rising to 3837 bcf on November 27. Surprisingly price did not react very rigorously during the period, suggesting US storage can accommodate more than we, as well as the market, had anticipated.

The number of gas rigs dropped drastically in 2009 as price weakness dis-incentivized production. However, the pace of decrease and increase in rig counts was out of expectations. To be more exact, the paces of the decline and recovery were faster than we anticipated. The number of gas rig counts dropped almost -60% to 665 units in July 2009 from 1606 units (record high) in September 2008. However, the correction seemed to have completed in less than 1 year and rig counts have increased gradually since then even though demand in gas remained fragile and inventory was still surging.



Precious Metals

After a robust November, gold price tumbled in December as USD strengthened and investors took profits after the relentless rally. The benchmark contract for gold lost -7.3% in December although the annual gain remained strong at +24%.

November was the best month for the yellow metal in 2009 as it set fresh nominal records for 15 out of 21 trading days during the month and recorded the largest percentage increase since September 1999. In November, the IMF announced it had sold 200 metric tons of gold to the Reserve Bank of India. This was the first time since 1995 that India bought gold and the total purchase represented half of IMF's total planned sales of 403.3 metric tons. Shortly after this, the IMF said that the central bank of Mauritius and the central bank of Sri Lanka had bought 2 metric tons and 10 metric tons of the rest of gold, respectively. Buying from central banks in emerging countries indicated a growing appetite for bullion holdings. This also boosted market sentiment.

It may be surprising that gold rallied despite its relatively weak physical fundamentals. Mine supply is expected to record the first increase in 5 years. According to the World Gold Council, mine supply rose +6.7% yoy in the first 3 quarters in 2009. At the same time, high gold price has damped jewelry demand and increased scrap supply. However, one should note that, apart from being a commodity, gold is also a 'currency'. Worries about USD depreciation and hyperinflation increased gold's appeal. We saw huge investment demand for the yellow metal this year as ultra expansionary monetary policies from global central banks raised concerns about currency debasement and inflation. We believe continuous capital flows to related ETFs and/or futures are required to maintain gold's strength in the coming year.

After tumbling in the previous year, silver, surging +49% in 2009, recorded the strongest gain in 3 decades. For PGMs, platinum rose +59% while palladium price more than doubled as auto sector showed signs of recovery after industry restructure and government assistance.



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