Geopolitical tensions have been directing the movement of oil prices since the start of the year. Sanctions against Iran in condemnation of its nuclear developments had sent oil prices higher. The US has imposed sanctions against Iran's central bank and it's highly likely that Japan and South Korea will reduce their imports of Iranian oil. The EU has in principle agreed ton an embargo on oil imports. However, an EU embargo on Iranian oil imports will likely be delayed for 6 months so that countries including Greece, Italy and Spain can find alternative supplies. Data from the European Commission indicated that these three countries accounted for 68.5% of EU imports from Iran in 2010. The news triggered a sharp selloff in oil prices on Thursday and Friday. In Nigeria, President Goodluck Jonathan will meet protesters in an attempt to end the 4-day strike which will affect the oil industry. Oil prices should continue to move with great volatility in coming months as long as geopolitical tensions remain uncertain.

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The DOE/EIA released its monthly short-term energy report last week, suggesting the price of WTI crude oil would average about 100/bbl in 2012, up +5/bbl from the average price last year. For 2013, the agency expects WTI prices to 'continue to rise, reaching 106/bbl per barrel in the fourth quarter of next year. Concerning global oil demand/supply, the DOE/EIA expects the tightening of world oil markets would 'moderate in 2012 and resume in 2013'.

Oil demand will probably increase +1.27 mmb, or +1.44% y/y, to 89.38 mmb in 2012. This, however, represents a -0.14 mmb drop from the projection made in December. The DOE/EIA also introduced the demand forecast for 2013. During the year, consumption will climb +1.47 mmb, or +1.44% y/y, to 90.85 mmb. On the supply side, non-OPEC supply is expected to rise +0.91 mmb, or +1.76%, y/y to 52.76 mmb in 2012, followed by a +0.76 mmb, or +1.44%, increase to 53.52 mmb in 2013. The need for oil supply from the OPEC will be 30.30 mmb and 30.76 mmb in 2012 and 2013 respectively.

Natural gas has been trending decisively lower after breaking below the 2010-low in mid-December last year. The milder-than-normal winter weather and the oversupply due to shale gas production have been the key reasons for the weakness in price. The DOE/EIA reported that gas inventory dropped -95 bcf to 3 377 bcf in the week ended January 6. Stocks were +398 bcf above the same period last year and +491 bcf, or 17.0%, above the 5-year average of 2 886 bcf. Separately, Baker Hughes reported that the number of gas rigs fell -20 units to 791 in the week ended January 12. Oil rigs stayed unchanged at 1191 units and miscellaneous rigs were flat at 5, sending the total number of rigs to 1987 units. Directionally oriented combined oil, gas, and miscellaneous rigs dipped -3 units to 213 units while horizontal rigs increased +1 unit to 1161 and vertical slipped -18 units to 618 during the week.

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Gold gained for a second week, signaling a temporary low has been formed at 1523.9 in late December. However, it's still too early to conclude that the yellow metal's correction since September 2011 has ended. After the decline in September, gold price dived another $200 in December. This was mainly driven by the demand for USD by European banks. As the ability of European banks to access to USD funding has dried up, they had to use the gold market as a source to get the US dollar. The phenomenon led to a sharp drop in the short-term gold lease rate during the period. As gold recovered some of its losses in January, it was preceded by the recovery of the lease rate. Despite recent rebound, gold continued to trade at the discount to the levels indicated by the US 10-year TIPS yields.

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Should European funding pressure ease, gold should eventually rise, at least in compliance with the levels suggested by US interest rates. We are not too pessimistic on the liquidity issue for European banks, especially after ECB's funding through LTRO. As President Draghi indicated at the January ECB meeting the 3-year LTRO has been 'providing a substantial contribution to improving the funding situation of the banks, thereby supporting financing conditions and confidence'. Indeed, the recovery in the lease rate has shown that the funding pressure facing European bank in the near-term has eased.

The correction since September does not suggest any change in fundamentals. Gold ETF holdings remained firm in the second half of last year. The SPDR Gold Trust, the world's gold ETF, recorded holdings of 40.3M oz, compared with all-time high of 42.1 in August 2011, in December last year, suggesting long-term investors are still confident over gold's outlook. Moreover, central banks' gold appetite has stayed robust and the official sector has remained a net gold buyer since 2009. European central banks have only sold 4.8 tons of gold so far in the 3rd year (September 27, 2011- September 26, 2012) of the CBGA3, compared with the annual target of 400 tons allowed. This also indicated that central banks did not feel the need to sell gold despite price correction.

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