Acceleration in China's tightening and fiscal problem in Greece caught the market's focus last week. While the former indicates slowdown in the pace commodity demand growth, the latter unveiled the risk of defaults in sovereign loans. Investors suspected recent rallies in commodities were excessive and therefore corrections were seen. The Reuters/Jefferies CRB Commodity Index slid -3.2% to 281.4.


Crude Oil

Crude oil price ended last week with 5 straight days' of drops. The February contract slid -5.7% to close at 78 for the week. Selling pressures were heavy amid concerns on abundant inventory, slowdown in growth momentum in China as well as strength in USD.

Early last week, China released preliminary imports data for December. The readings were strong in most commodities. According the Customs, crude oil imports surged +24% to 21.26M metric tons during the month. On annual basis, the nation imported 203.8M metric tons in 2009, compared with 178.9M metric tons a year ago. The market was thrilled by the news and WTI crude oil price rallied to as high as 83.95, the highest level since October 13, 2008. In fact, emerging market, especially China, has been viewed as the demand growth driver for commodities. Anticipation for robust Chinese consumption has contributed for the 78% rally in crude price in 2009.

A Chinese proverb says 'while water can float a boat, it can also overturn a boat'. In order to stimulate investment and spending, the Chinese government implemented a RMB 4 trillion stimulus program, including government subsidies and tax breaks for home appliances and cars, last year. This has helped restored strong economic expansion in the world's third-largest economy. However, the record amounts of lending has also increased risks of asset bubbles and over-heating in the economy. Therefore, the government began cooling since January 2010.

After guiding open market interest rates higher, the People's Bank of China raised, for the first time since 2008, the reserve requirement ratio- the proportion of deposits that banks must set aside- by 50 bps last Tuesday. Currently the reserve ratios for small banks and large banks are 13.5% and 15.5% respectively. The lift indicated a further step to unwind the accommodative policies it implemented last year.

China's move depressed commodity investors and energy prices got hammered. As China tightens, a large number of investment and infrastructural projects will be delayed or cancelled. This, in turns, will slow down demand for commodities such as energies and industrial metals. Investors' worries were intensified as demand in OECD economies remained dismal.

On Wednesday, the US Energy Department reported surprising increase in crude and oil product inventories. Crude oil stockpile in the US, the world's largest oil consumer, rose +3.7 mmb to 331 mmb. Increase in capacity utilization caused both gasoline and distillate inventories to rise, by +3.79 mmb and +1.35 mmb, respectively. The set of data indicated demand weakness for petroleum. While global oil demand is expected to improve this year as economic recovery accelerates, current consumption in the US remains sluggish. Crude oil price should continue trading below 80 in coming weeks. In the longer-term, should oil wish to break above recent trading range, significant improvement in OECD demand is a pre-requisite.

Natural Gas

Gas price slid -1% to 5.691 last week. The US Energy Department reported storage declined -266 bcf to 2852 bcf in the week ended January 8. Inventory on January 1 was revised down from 3118 bcf from 3123 bcf. Although extremely cold weather in December increased demand and tighten the market, the impact is short-lived. Meteorologist forecast milder climate in the Northern hemisphere in coming weeks. Moreover, significant rise in US LNG imports suggests supply should remain ample in coming months.

Total natural gas consumption probably dropped -1.5% to 62.45bcf/day in 2009. According to EIA, higher natural gas price this year should reduce consumption in the electric power sector by -2.8% but the decline will be offset by modest growth in the residential, commercial, and industrial sectors. On net, the demand should be remain unchanged in 2010.

The number of rigs increased 30 units to 811, the highest in 10 months, in the week ended January 15. Rig counts have been rising sharply after hitting a bottom of 665 units in July 2009. However, it remains -34% lower than the peak of 1600 units in September 2008.

In 2009, the number of rigs plummeted -44% on annual basis. However, production was not at all impacted. Total marketed natural gas production increased +3.7% last year. The US Energy Department said that it was due to the lagging effect of reduced drilling activity and expected production to drop-3% in 2010 before rising +1.3% again next year.



Precious Metals

Gold plunged -1.1% Friday as USD rebounded strongly against major currencies. The dollar index gained +0.8% Friday after dropping for 5 days. On weekly basis, the yellow metal, losing -0.7%, traded sideways within a range of 1120 and 1160, probably because the dollar also lacked direction.

Gold futures gained +24% in 2009. However, USD index plummeted -4% during the period. Apart from weakness in USD, gold's rally was driven by a series of other factors including robust investment demand in ETFs, official buying and reduction in central bank sales.

In 2010, performance of gold may continue to underperform that of silver and PGMs as gold is less leveraged to global economic recovery than these metals.

We believe platinum and palladium will shine this year and there are several factors leading to the outperformance.

According to Johnson Matthey (JM), global platinum demand from automotive industry probably fell -33% to 2480K oz, the lowest global figure for demand since 2000, in 2009.The sharp decline was due to collapse in the auto market in late-2008. Global light duty vehicle production is expected to have droop -16.1% to 57.2M units last year. However, as economic outlook improves, auto sector should recover in a rapid rate and drive up demand for platinum.

Another issue is investment demand which should strengthen further in 2010 and 2011. The recently approved platinum ETF in the US is positive will have huge impact on the market as it can lead to several hundred thousand oz of additional investment.

On the supply side, production may rise further in 2010 but there're lots of uncertainties as power outage, labor strike and downgrades of mines in South Africa increase the risk to the downside.