The Fed surprised the market Thursday by raising the discount rate to 0.75%, the first time in more than 3 year, from 0.5%. The Fed reiterated that the move is not a prelude of a change in monetary policy. Policymakers stressed that the fed funds rate will stay exceptionally low for an extended period of time.
January's US CPI missed market expectations and core PPI even slipped to deflationary territory. This helped easing investors' concern about Fed's exit strategy. However, the rate hike was still viewed as a step-up of the Fed's unwinding of stimulus measures. The Fed funds futures factored in 70% chance Friday that the central bank will increase its policy rate to at least 0.5% by November, compared with 65% in the prior day.
Greece's deficit problem remains a big question mark. While EU's statement helped soothe Greece's issue temporarily, it has not done anything in material to resolve the issue. Germany, the largest economy in the 16-nation Eurozone, stressed that the Union is helping Greece 'politically' rather than 'financially'. Horst Seehofer, head of the Christian Social Union and a leader of Chancellor Merkel's Bavarian political allies, said that 'we are stable-currency party' and 'not a single euro will go to Greece'. The comment triggered selloff in the euro and rallies in USD and JPY.
Over the week, USD index edged +0.4% higher while Reuters/Jefferies CRB Index gained +3.7%.
Crude Oil: Despite selling pressure in Asian session Friday, crude oil price found support at 77.76 and rallied strongly to as high as 80.1. The black gold ended the day and the week at 79.81, gaining +0.9% on daily and +7.7% on weekly basis.
The dramatic daily reversal was driven by strength in equity markets, supply worries due to a strike in France and escalated tension in Iran.
US headline CPI rose +0.2% m/m (consensus: +0.3%; Dec: +0.1%) in January while core CPI actually contracted -0.1% m/m, for the first time since December 1982, during the month. On annual basis, the headline CPI rose +2.6% (consensus: +2.8%; Dec: +2.7%) while the core added +1.6%. Weaker-than-expected inflation readings indeed eased investors' worries about the Fed's tightening. The market was also relieved after several Fed members, including Chairman Ben Bernanke, New York Fed President William Dudley and St Louis Fed Kames Bullard, reiterated the policy rate will stay low for an extended period.
In a protest against the possible shutdown of a refinery plant, workers at Total's 6 French oil refineries extended a strike Thursday, making some petrol stations running out of fuel in the next few days. Total supplies 53% of oil and gas in France.
Geopolitical tensions between Iran and the western world over nuclear weapons escalated. According to a report from the International Atomic Energy Agency (IAEA), there are concerns about the 'possible existence in Iran of past or current undisclosed activities related to the development of nuclear payload for a missile'. It's highly likely for the UN to import more sanctions on the Iran which rejects accusations that the nation is developing nuclear weapons. Iranian Supreme Leader Ayatollah Ali Khamenei said the US Secretary of State Hillary Clinton is spreading 'lies' by saying Iran is turning into a 'military dictatorship' during her visit to the Persian Gulf. Oil prices historically demonstrated high direct correlation to geopolitical unrests.
Last week's rise in oil price was driven by market sentiment rather than oil-specific fundamentals. In fact, the demand/supply outlook in the energy market remained sluggish. According to the US Energy Department, crude oil inventory surged +3.09 mmb to 334.5 mmb in the week ended February 12, driven by +2.5% surge in imports. Refinery runs surprisingly improved with utilization rising +0.6% to 79.8%. Gasoline stockpile built by 1.62 mmb to 232.1 mmb. Demand plunged -2.8% to 8.521M bpd, reversin the +1.8% gains made in the previous week. On annual basis, current demand level remains -4.3% below last year. Distillate was the only sweet spot with a draw of -2.94 mmb. Imports fell while demand soared +2.5% to 3.787M bpd as extremely cold weather boosted consumption. However, demand remains dismal as it is -13% less the same period last year and -20% below 5-year average.
In coming weeks, central banks' attitudes towards unwinding previous stimulus measures and sovereign debt issues in the Eurozone will continue to be the key factors determining oil prices. In the medium- to long- term, however, whether price can break above recent trading range of 70-80 hinges on the pace of economic recovery.
Natural Gas: Natural gas tumbled -7.8% last week with the selloff accelerating after release of the gas inventory report Thursday. Gas storage drew -190 bcf, inline with market expectation, to 2025 bcf in the week ended February 12. Inventory level remained +2.7% above 5-year average. Investors were disappointed by the above-normal inventory level and concerned that the gap will widen as winter is coming to an end. In fact, weather forecasts in the mid-Atlantic region of the US have trended warmer for early next week. This may reduce heating needs.
The number of gas rigs increased only 2 units, the smallest addition in 8 weeks, to 893 units last week. Chesapeake Energy Corp, the second largest natural gas producer in the US, said that it will increase production in oil as it will be more profitable than gas. The company said last week that it targeted to increase oil production to 15.5 mmb, up +31% y/y, this year. Gas production will shrink as it scales back gas drilling in some areas after contract expiration in 2011. However, it doesn't mean decline in supply of natural gas as the company will also accelerate drilling in areas, such as Eagle Ford shale in South Texas, that produce liquid gas. We believe this will be the trend in the natural gas market to go 'liquid'.
According to a report by Barclays Capitals, the Eagle Ford shale is the 'latest craze in shale drilling' as it has 'prolific initial results and a high percentage of liquids production'. 'Producers are moving rapidly to drill into the Eagle Ford. From a trough of 17 rigs over the summer, recent data show the rig count has increased to more than 40, with the vast majority of these rigs targeting the shale...Producers that have reported strong well results have been rewarded with higher equity valuations for their involvement in the Eagle Ford'. Although current production remains low, the potential is large.
Precious Metals: Gold price, adding almost 3%, moved with great volatility last week. The 2 main factors directing the yellow metal's movement were IMF's disposal of its gold reserves and the Fed's unexpected increase in discount rate.
IMF said on February 17 that IMF said it will be selling the rest (191.3 metric tons) of its approved gold sales (totaling 403.3 metric tons) on the open market shortly in a phased manner over time.
Since the approval of gold sales in September 2009, the IMF has already sold 212 metric tons Reserve Bank of India, Bank of Mauritius and Central Bank of Sri Lanka. The fact the world lender now looks to sell the remaining of gold in the market, rather than off-market, may signal there's no buyers in the official sector. The Central Bank of Sri Lanka has already stated it's unlikely to purchase more gold for now.
Purchase of gold from central banks remains pivotal for the metal's outlook. US debts held in China dropped -4.3% m/m to 755.4B in December. China has also become a net seller of US government debts for a second consecutive month. China's holdings of US Treasury peaked at 801.5B in May and the decline has been increasingly significant in recent months. The situation may signal the Chinese government is diversifying its reserve away from USD-denominated assets as the country has been questioning about the security of US debts given the heavy budget deficits in the US.
If China accelerates its diversification process, we believe gold will benefit as the precious metal is an appealing alternative. In fact, the Chinese government reported in April 2009 its gold reserves increased, by +75.7%, for the first time since December 2002 to 1054 metric tons.
It's possible for China to purchase IMF's gold but we are not certain. Increasing gold reserve not only can help it diversify its reserves but also can help support the RMB as a global currency. Buying IMF's offer will raise China's total gold reserve by 18%, based on the 1054 metric tons of Chinese reserves reported in April 2009. However, China has become the world's largest gold producer and is able to buy its own gold. This was also a possible reason for it not to participate in IMF's sale last year.
Increase in discount rate by the FED boosted USD, hence, pressured gold. Although the yellow metal managed to rebound around 1100 to close at 1122.1 Friday, it's near-term trading will remain choppy - as the 2 key issues mentioned above will be affecting market sentiment in coming weeks.
Others in the precious metal complex also rallied with silver and palladium outperforming gold and platinum.
In the ETF universe, capitals flew from PGM ETFs to gold and silver ETFs. ETF Securities' data showed than holdings for platinum declined by -1.2% w/w while palladium rose +7.4% w/w last week. Meanwhile, holdings for gold and silver rose +3.2% and +0.4% respectively during the week. PGM holdings in the US-listed ETFs were flat.
Base Metals: Base metals strengthened last week with copper, nickel, lead and zinc the best performers. Market sentiment improved while macroeconomic data suggested demand for base metals is rising. While the market has focused on China, recognizing it as the biggest driver for demand growth, recent data signaled that non-China consumption is turning the corner.
LME cancelled warrant rose for most metals, suggesting inventory in the LME is flowing out. Moreover, upside surprise in US industrial production and Empire State manufacturing, as well as robust ZEW index in Germany were evidence that the recovery in the sector is on track.
In the coming week, base metal movements will be volatile, especially when Chinese market reopens after Lunar New Year Holiday.