The commodity sector experienced great volatility last week as mainly driven by renewed concerns over sovereign debt problems in the Eurozone. Slump in risk appetite and strength in the US dollar resulted in the decline of commodities during the week. The market was not impressed by the outcome of EU summit. Rather, it was disappointed by the plans agreed during the meeting. Fitch Ratings lowered France's credit outlook to negative despite affirmation of the AAA rating. According to the rating agency, the 'risk of contingent liabilities' has been 'heightened' and France has almost run out of buffers to absorb shocks 'without undermining its AAA status'. Moreover, 'the intensification of the euro zone crisis since July constitutes a significant negative shock to the region and to France's economy and the stability of its financial sector'. Fitch's also put the ratings of European countries such as Spain and Italy on review for a downgrade.
IMF's Lagarde warned last week that 'the world economic outlook at the moment is not particularly rosy. It is quite gloomy'. Concerning the sovereign crisis in the Eurozone, she stated that 'there is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super-advanced economies that will be immune to the crisis that we see not only unfolding but escalating' and the world would head to 'Great depression' if the crisis cannot be solved.
Worries over the crisis in the 17-nation region overshadowed the better-than-expected US macroeconomic data. Initial jobless claims surprisingly declined to 366K in the week ended December 10 from 381K a week ago. The market had anticipated a rise to 390K. The 4-week moving average fell -7K to 388K, the lowest level since July 12. Moreover, continuing claims climbed only +4K to 3603K for the latest week. Manufacturing sector in Philadelphia and New York also unexpectedly improved. The Philly Fed Index rose to 10.3 in December from 3.6 in November while the Empire State Manufacturing Index improved to 9.5 from 0.61. The US Senate will vote on 2-month extensions of a payroll tax cut, expanded unemployment benefits and a provision approving an oil pipeline project from Canada to the US Gulf of Mexico.
Crude Oil: Oil prices tumbled last week. While the uncertainty in the Eurozone continued to drag on prices, the major reason for the slump was OPEC's announcement of raising the cartel's production ceiling. For the first time in 3 years, the OPEC increased its production ceiling to 30M bpd so as to make room for rising exports from Libya. The new quota, replacing the current target of 24.85M bpd for OPEC -11, is for all members of the cartel, including Iraq and Libya, and comes in line with total OPEC production in recent months (e.g.: production in November was 30.37M bpd while that in October was 29.81M bpd). Oil ministers also agreed that the target will be reviewed at its next meeting on June 14.
Quite different from previous policy decisions, the OPEC did not mention individual quotas. It also did not give any oil price band. Rather, the cartel unusually emphasized a targeted inventory build of 650K bpd in 1H12. The latest data from the IEA showed that total OECD oil inventory was at 2630 mmb as of October, -62 mmb below 5-year average levels. Stocks in Europe have been particularly low as affected by supply disruption in the North Sea and Libya. The inventory target was probably a response to turmoil in oil producing countries and rising geopolitical tensions since the beginning of this year.
The agreement made this month was in great contrast with the June meeting. However, in the long-term, interests of individual OPEC members vary a lot. Indeed, the decision made this time is expected to lead to a decline in oil prices with WTI and Brent prices falling to 90 and 100 respectively. This would affect member countries with high breakeven oil prices. From the perspective of breakeven prices and oil output Saudi Arabia, Kuwait and the UAE will have greater influences among other members.
Natural gas: Natural gas remained under pressure. The DOE/EIA reported that gas inventory dropped -102bcf to 3729 bcf in the week ended December 9. Stocks were +154 bcf above the same period last year and +347 bcf, or 10.3%, above the 5-year average of 3382 bcf. Separately, Baker Hughes reported that the number of gas rigs fell -2 units to 818 in the week ended December 16. Oil rigs added +35 units to 1196 and miscellaneous rigs fell -1 unit to 5, sending the total number of rigs to 2019 units. Directionally oriented combined oil, gas, and miscellaneous rigs dipped -4 units to 213 units while horizontal rigs increased +33 units to 1184 and vertical climbed +3 units to 622 during the week.
Precious Metals: Precious metals got hammered as they moved more in tandem with others in the commodity complex rather than as safe haven assets. After surging to a record high of above 1900 in September, gold has been undergoing a correction. The bearish trend in recent month has led to worries that the yellow metals annual gain over the past 10 years may be paused in 2011. Over the past decade, gold delivered average annual returns of +18% while inflation was averaged at +2.5%. Quantitative easing measures by the Fed were the most important driver of the gold price over the past few years. Unconventional easing measures implemented by central banks are 'money-printing' in nature and in so doing, policymakers intentionally depreciate currencies of their countries. While currency depreciation would drive investors from fiat currencies to gold, it does not benefit gold price to the same extent. Indeed, ECB's easing would send the euro lower. Given the high correlation of the euro and gold, the price of gold may be affected if the ECB introduce QE measures.
Despite recent correction, we retain the view that gold will resume the uptrend and rise to 2000 next year as long as central banks leave interest rates at exceptionally low levels. However fiscal tightening in Europe and the US may be a drag on gold price. This may postpone the uptrend and the reach of new high to 2013.