While moving at a modestly bearish tone for most of the week, financial markets strengthened on Friday as the US non-farm payrolls beat expectations. The number of jobs gained +163K in July, up from the downwardly revised +63K a month ago. The market had anticipated the July addition would be +100K. The unemployment rate climbed higher to 8.3% in July, as the number of unemployed increased by +45K, compared with 8.2% in June. Wall Street jumped with the DJIA and the S&P 500 gaining +1.69% and +1.90% respectively. Earlier in the week, investors' sentiment was affected by central bank decisions. Both the Fed and the ECB held meetings during the week. While both central banks were expected to act further so as to stimulate the economy, both disappointed by staying on the sideline.
The Fed disappointed the market as policymakers refrained from delivering any new measures to boost the deteriorating economy. The Fed continued to maintain that interest rates will maintain low at least until late 2014. While acknowledging the economic development have deteriorated the Fed chose a wait-and-see mode so as to gauge the impacts of the extension of operation twist. In the August statement, the Fed said that 'economic activity decelerated somewhat in the first half of this year', compared with 'economy has been expanding moderately' in the previous month. Moreover, the statement acknowledged 'further' signs of improvement in the housing sector, but maintained that the sector was 'depressed'. the Fed pledged that it would 'closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery', while in the previous statement it said that it's 'prepared to take further action as appropriate to promote a stronger economic recovery'. The change indicated that policymakers have turned impatient with the pace of recovery in the job market. It's yet uncertain whether the more-than-expected payroll addition in July might further delay Fed's action.
The ECB left the main refinancing rate unchanged and announced no bond purchase program. At the press conference, President Draghi reiterated his comments made last week in London that there's a need to contain risk premia in the bond yields of some countries. Although policymakers did not step up easing measures in August to boost the economy and to resolve the crisis, President Draghi stressed that bond purchases would be reactivated. Regarding this, Draghi stated that the ECB would only support countries that have requested funding from EFSF / ESM and have accepted the accompanying conditionality. This pre-requisite is inline with our forecast. Moreover, Draghi stated that bond purchases by the ECB would be under a different modality from the SMP- the purchases would be made with high transparency and would focus on the short-end of the yield curve. Draghi's reiteration that "irreversibility" of the euro meant that it was impossible to go back "to the Lire, to the Drachma" indicated his, and the ECB's, commitment to sustain the single currency.
Crude Oil: Friday's rally has saved crude prices from recording losses for a second consecutive week. Concerning front-month contracts, WTI crude gained +1.41% while Brent crude soared +2.32%. After a brief fall to contango in June, ICE Brent returned to backwardation in July and the spread has been widening in recent days. The key reasons for the situation are sanctions on Iran and potential decline in supply of Forties as a result of an export program in September.
Strength in oil prices was helped by the US' and its allies' sanctions on Iran's oil exports The Bloomberg data showed that Iran's shipment has dropped -1.2M bpd since the EU sanctions became effective on July 1. This represents around half of the original output of the Middle East country. In coming months, the situation will likely be tighter as the US intensified sanctions by penalizing foreign banks that handle transactions for National Iranian Oil Company (NIOC) or its subsidiary Naftiran Intertrade Company. Moreover, the US placed sanctions on China's Bank of Kunlun and Iraq's Elaf Islamic Bank. Note that the Bank of Kunlun is a regional bank in western Xinjiang province with 82% held by CNPC, this round of sanctions would further limit China's ability to buy crude oil from Iran.
The Brent crude contract is based on 4 North Sea crude oils - Brent, Forties, Oseberg and Ekofisk. While Forties is the largest stream and the most important oil for setting prices, its supply is expected to decline as Nexen has planned to close Buzzard, the largest field with over 70% oil feed to Forties, for maintenance.
Natural Gas: Nymex gas price slumped Thursday due to the broad-based selloff in financial markets after the ECB's disappointment. The decline was certainly also driven by the increase in supply of +28 bcf to 3 217 bcf in the US in the week ended July 27. Stocks were +472 bcf higher than last year at this time and +407 bcf above the 5-year average of 2 810 bcf. While gas price will likely report losses for the second consecutive week, it has indeed surged more than +50% from the lowest point in April. We attribute the rally to two key reasons: coal-to-gas replacement and hot weather. In 1Q12, market fears that oversupply in gas would fill storage earlier than usual had sent prices lower. As a result, Nymex gas price plummeted to a decade-low in April. Selloff in gas prices has, however, attracted demand from power generators with the power sector chose to run gas-fired plants instead of coal-burning ones due to lower costs. However, this kind of demand for gas is highly dependent on low gas prices. Indeed, some in the sector have already switched back to coal with recent rally in gas prices.
Power consumption has also been support by hotter-than-normal weather in this summer. This factor will continue to help in August and as long as the weather is "hot enough", robust demand would sustain current price levels. However, as winter comes, we believe price will falter and probably slip back to $2 range.
Precious Metals: Gold price continued to fluctuate around 1600, with disappointments of the Fed and the ECB being the major drivers of the decline. While gold was the only metal in the complex that recorded weekly fall last week, the chart below showed that gold-to-platinum ratio has continued to go up. Indeed, the ratio has reached a record high on July 27. We expect the uptrend to continue. Although platinum had found support from buying in China previously, physical demand has been, and would remain, weak due to the deteriorating outlook in Europe.