Confidence was being tested last week but strong buying on Thursday and Friday signaled it's still there. Focus remained to be the debt situation in Greece and economies nearby. Earlier in the week, S&P cut credit ratings of Greece by 3 notches to BB+ (junk) and Portugal by 2 notches to A-, placing both countries in 'negative' outlook. This escalated concerns about Greece's default and contagion to peripheral European economies. These downgrades, followed by a rating cut on Spain, triggered panic selling in various asset classes including stocks, currencies and commodities. However, risk appetite rapidly recovered as the EU and the IMF pledged to conclude the rescue package to Greece over the weekend.

The market then paid more attentions to macroeconomic data and corporate earnings results. Generally encouraging data and stronger-than-expected earnings in the first quarter lifted equities which in turns boosted crude oil prices. On Friday, US' economic growth in 1Q10 slightly missed expectations. GDP expanded +3.2% q/q (annualized rate), compared with consensus of +3.4%. However, consumer spending grew at the fastest pace in 3 years and suggested growth should accelerate in coming quarters. This, accompanied by better-than-expected Chicago PMI and University of Michigan confidence index, sent oil prices higher.

We believe current oil price has been too high to be justified by fundamentals. Although strong market sentiment may continue to boost price higher to 90 or above, without evidence showing meaning pickup of demand and decline in inventories, severe correction is likely.

Worries above European sovereign risk has greatly increased physical demand for gold. We expect the problem will persist as there are signs that the problem in Greece is spreading to other parts of the Eurozone. This should be positive for gold.

Crude Oil

Oil Prices registered another strong week despite weakness on Monday and Tuesday. The front-contract for WTI crude oil price settled at 86.15 Friday (intra-day high 86.5, the highest level since April 6), surged +1.21% on weekly basis while gaining +2.85% in April.

Price movement was volatile last week. Oil was sent to as low as 81.29 earlier in the week as S&P's downgrades of Greece and Portugal triggered worries about defaults in Greece and contagion of sovereign crisis in peripheral European countries. Confidence picked up later as European leaders pledged to resolve Greek debts as soon as possible and economic data from both the US and Europe suggested global recovery remained in progress.

Since the beginning of March, trading range of crude oil has been moved upward to 80-90 from 70-80, a range prevailed since the middle of last year. In early April, price even reached 87.09, the highest level in 18 months.

In our view, rally in oil price has been driven by the theme of global economic recovery which fueled expectations of an eventual tightening of oil fundamentals. Oil prices have been tracking stock markets closely. Strong 1Q10 corporate earnings lifting equities have also boosted oil prices. On the contrary, industry-specific data showed that end-market demand remained dismal and the situation would get worse if governments withdraw fiscal and monetary stimuli.

While we cannot deny recovery in oil market, the improvement mainly focuses on emerging countries. In most part of OECD countries, demand has been stagnant. In other parts, especially in European, the situation is even worse. IEA forecasts oil demand growth in OECD Europe will drop -0.7% this year, making it the 4th annual consecutive drop. The decline is dramatic as it follows a -5.6% fall in 2009.

Demand growth in Europe is subject to downward revision given the airspace closure due to volcanic eruption in Iceland this month. According Deutsche Bank's estimates, the 7-day air traffic disruption has reduced global jet fuel demand by around -1M bpd, of which Europe accounts for 70-75%.

In the US, crude oil inventory rose +1.96 mmb (consensus: +1.4 mmb) to 357.8 mmb in the week ended April 23. Gasoline inventory level drew -1.24 mmb, compared with market expectations of a gain of +0.5 mmb as the -2.03% drop in production was only partly offset by +30.3% increase in imports. Demand rose +1.51% to 9.29M bpd. Distillate stockpile, however, rose +2.94 mmb to 151.8 mmb despite +3.69% increase in demand. Both imports and production soared, by +138% and +2.61% respectively.

The pronounced contango situation in WTI crude oil futures driven by huge stockpiles at Cushing Oklahoma has improved this week. This was probably driven by slowdown in stock-builds at the region. Cushing stockpile will continue to drop in coming weeks as refinery activities return from maintenance.

To us, actual demand and inventory levels are much weaker than what has been suggested by oil prices. The market is expecting to see more evidence showing the OECD market is improving or a quite severe selloff will be seen after strong rallies in the second quarter.

Natural Gas

A completely different story is seen in natural gas as investors seem to have lost hopes that demand growth can offset huge production growth.

Gas price slumped Thursday after the US Energy Department reported that storage rose 87 bcf in the week ended April 23. At 1912 bcf, gas inventory exceeded 5-year average by 18.8%, compared with 18.5% in the prior week.

Another disappointment came from the US Energy Department's monthly production report. While production estimates for both January 2009 and January 2010 were revised down, by -0.2 bcf/day and -0.6 bcf/day respectively, the downward revisions were too mild despite use of more recent information and company samples. The result suggested increases in shale gas output were real. Added to the worries was that gas output in February rose +1.6% to 63.85 bcf from a revised 62.85 bcf in January.

The number of gas rigs rose +2 units to 958 units in the week ended April 30, after dropping -17 units in the prior week.

Precious Metals

Gold climbed higher on Friday despite apparent ease in worries over Greece's debt problem. The benchmark contract soared to as high as 1182.5, the highest level since December 2009, before closing at 1180.7, signaling a number of investors remained unsettled about sovereign crisis which might erode the value of currencies.

Historically, decline in risk appetite has driven capitals into USD and JPY. Gold, categorized as a commodity, normally plunges with others in the sector as investors seek safe haven. However, European sovereign event risk has also boosted investment demand in gold. SPDR Gold Trust, the world's biggest gold ETF, recorded a +1.6% increase in holdings last week to a record high of 37.3M oz.

We remain bullish in gold's outlook in the long-term and expect further upward pressure on gold prices should worries about sovereign crisis in Greece and peripheral European economies escalate.

Although PGMs apparently underperformed last week with platinum gaining only +0.2% while palladium losing -1.32, both metals recorded prominent gains in April. During the month, platinum surged +5.96% while palladium jumped +15.8%, the strongest rally since February 2008.