A dollar surge and risks reduce tumbling send gold and oil

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By John Kicklighter, Currency Strategist Wed Oct 20 00:16:00 GMT 2010 North American Commodity Update

Commodities - Energy

US Oil Breaks Two-Week Congestion as Risk Appetite Stumbles

Crude Oil (LS Nymex) - $79.49 // -$3.59 // -4.32%

Energy trades have grown accustomed to significant bear swings over the past few weeks; but these intraday declines have generally been restrained to the bounds of congestion between $83.85 and $80.50…until we came to Tuesday’s plunge. The 4.3 percent tumble was the biggest daily loss since May 20th on a continuous contract basis; while the November contract (which is due to expire tomorrow) suffered its largest loss since February 4th. Aside from this particular loss reflecting a very active session, the real interest in Tuesday’s performance was the fact that it would push the commodity outside the bands of its two-week range. This is the development that can have greater meaning as trend development rather than simply just a large but ultimately limited move.

For fundamental drive, there is an argument to be made for both fundamental supply-and-demand factors and risk appetite conditions supplying the prevailing winds. Ultimately, both catalysts would align; but identifying the more influential element is important for establishing the stability of this fledgling trend. For growth factors, there were a number of top tier economic indicators on the calendar. In the European session, German Investor confidence (the ZEW survey) fell to its lowest level in 21 months while the UK CBI factory orders reading reported its sharpest decline in two years with the October reading. In the US, the focus was on the housing market with September housing starts rising to a five-month high – not that impressive a statistic when we consider how depressed the housing market is. What was the ultimate market-moving impact of this round of macro data? Low. The real growth threat was the news that China hiked its benchmark lending and deposit rates for the first time in three years. This holds clear implications for restraining growth (though it is aimed at preventing asset bubbles).

The other general theme for the day – and ultimately the greater driver – was risk appetite itself. The benchmark S&P 500 dropped 1.6 percent on the day while the dollar saw its largest rally since August 20th. Speculative confidence was bled partly by the move from China; but a rapid loss of confidence in the Fed’s potential stimulus expansion early next month certainly holds an overwhelming influence on this front. This is front where a true trend would develop; so an eye should be kept on oil and equities.

For trading activity, the API industry inventory figures would add to selling pressure with a 2.32 million barrel increase in net crude holdings. This sets up forecasts for a 1.5 million barrel increase in the DoE crude holding figure tomorrow nicely. In the meantime, the November Nymex futures contract expires tomorrow, which likely helped push volume on the December contract up 59 percent to a record 450,997.

Crude Futures Chart (Daily)

Chart generated using FXCM Strategy Trader

Commodities - Metals

Gold Suffers a Potentially Trend-Ending Plunge in the Biggest Drop in Over 3 Months

Spot Gold - $1,332.05 // -$36.40 // -2.66%

After two months of an impressive but restrained advance, gold started to show the symptoms of volatility in October. Initially this enhanced level of trading activity fell in line with the prevailing trend; but higher volatility also exposes a market to a quick reversal. And, we would get just such a break through Tuesday’s session. With this past Monday and Friday’s performance, the argument of a curbed advance could be made; but there was little debating the meaning of yesterday’s development. The 2.7 percent decline was the biggest decline for spot gold since July first – well before the remarkable bull trend set in. More important than the open to close change is the fact that the metal has broken the rising trend that had accelerated its climb back on September 14th. Now traders must ask themselves whether this is the mark of a true reversal or simply an overdue correction to shake out nonbelievers.

It is early to call a true reversal on gold; but fundamentals can clarify investors’ intentions. What is particularly meaningful in Tuesday’s developments is the high correlation across the various asset classes. Not only did gold mark a sharp retracement; but equities slid, the US dollar rallied and crude fell. This is an important mix that closely reflects the consistent flows between high yield (risky) assets and safe havens back during the 2007-2008 financial crisis period and the subsequent recovery period. Confidence in yields and nascent growth were shaken through the session first by the news that China’s central bank had raised its benchmark lending and deposit rates for the first time in three years. What effect does this have on global financial markets? Such an effort to curb expansion (and indirectly expected returns on the country’s investments) lowers the potential for capital performance in one of the world’s best performing economies and markets. If China believes growth trends are overleveraged, speculators are the ones that have passively fed the obligatory advance. What’s more, today’s drop in risk appetite persisted through a round of Fed commentary that not only supported stimulus expansion but further offered details on the approach. It seems this eventuality is more or less priced in; and there is growing skepticism surrounding its effectiveness in supporting growth and investment. Given this mix, it may seem surprising that gold – a traditional safe haven – would fall alongside equities. This development is a factor of the dollar’s strong performance. A lot of investment has been made on leverage given low market rates. However, there is still a heavy fundamental argument to be made in gold’s safe haven appeal which could keep the metal’s trend.

For trading activity, it is interesting to note that the CBOE volatility index showed a jump in response to today’s trading level; but it wouldn’t rise above the high from two weeks ago. Furthermore, the 243,671 contract turnover (while an 82 percent increase from Monday) was still below Friday’s high for the December futures contract.

Spot Silver - $23.37 // -$0.96 // -3.93%

With risk appetite sliding and gold tumbling, there was little for silver traders to fall back on. Speculative efforts to close a perceived value gap between gold and silver has contributed to the latter’s aggressive run; so when this trading interest is undermined; we are left with the biggest daily loss since July 1st. That being said ETF holdings of silver rose to a record 459.1 million ounces.

Spot Gold Chart (Daily)

Chart generated using FXCM Strategy Trader

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Written by John Kicklighter, Strategist

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Wed Oct 20 00:16:00 GMT 2010

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