Commodities were generally lower over the past week, despite another round of stimulus from the US Federal Reserve and the Bank of Japan. This initial reaction, at least for now, must come as a great relief to central bankers, who in the past have stood accused of fuelling the rise of raw material and food costs via quantitative easing. The dollar, which had been sold ahead of the announcement, also recovered some of its poise following weak economic data from China and the Eurozone.
Looking at the table below, we see just a few commodities managing a positive performance following the announcement of QE3, with iron ore sticking out as its dramatic recovery from the recent slump continues. The broad-based DJ-UBS commodity index is down three percent, having fallen more than what it rose in the week leading up to QE3, with the energy sector in particular (-4.4 percent) and agriculture (-4.6 percent) pulling it lower. The best performer during the week were precious metals (+1 percent) while industrial metals succumbed to some profit taking which stills leaves the sector the best performer over the last month.
The unleashing of QEInfinity, as it is now popularly being called, by the US Federal Reserve triggered a renewed push higher for crude oil. But just like HC Andersen’s fairy-tale “The Emperor’s New Clothes” it did not take long before someone realised that things did not stack up and that QE alone was not going to carry oil prices higher, considering the still weak outlook for economic activity. The dislocation from fundamentals only lasted until Monday, when a huge sell order late in the day triggered what can best be described as a flash crash with Brent crude dropping by four dollars in seconds.
Over the following days the correction continued, and by Wednesday it accelerated once again, when previous support at the 200 day moving average — an important level used by technical traders — gave way. In the end Brent crude fell by nine percent to a six-week low at 107.10 before finding support, with the news flow also supporting the move. Saudi Arabia once again stepped in with some verbal intervention in order to talk the price of Brent crude back down to the $100 level. Both the Saudis and the International Energy Agency see the market as being well supplied, which does not justify recent high prices, and any extra demand will be met by increased production.
On the economic data front, the Euro gave back some of its recent strong gains versus the dollar, as data showed that Eurozone manufacturing contracted for the 13th consecutive month in August. In China the HSBC flash PMI index stabilised but remained weak below the 50 mark, which points to contraction, and it points towards an even weaker growth number for Q3 than the 7.6 percent witnessed in Q2.
Geopolitics related to Iran have taken a backseat for now but worries about Libya’s weak security situation following the attack on the US consulate in Benghazi means that foreign oil workers may hesitate returning to the country thereby putting output at risk. Supply side worries with a price negative impact adds to the confusion as the potential release of oil from strategic reserves still lingers. This is particularly so in the US, where persistently high gasoline prices are a worry for President Obama as we hit the business end of the US presidential election campaign.
With the 200 day moving average at $111.80a barrel on Brent crude broken, I will be looking for a new trading range to be established between that and support at 107.00. Hedge funds and other leveraged accounts have been forced out of recently established long positions and are probably not that desperate to get back in unless we see a snap recovery back above 111.80. For now though the risk seems skewed to the downside due to the risk of additional position reduction, potentially down to 103.72 being the 50 percent retracement of the June to September rally.
Following the announcement of QE3, two of the expected main beneficiaries of such a stimulus injection, gold and silver, actually spent the week consolidating. This made good sense considering how far the two metals had already rallied ahead of the event. As it turned out, support around 1760 on gold and 34 on silver was established.
One of the supporting side effects of the additional and open-ended stimulus announced by the US Federal Reserve has been a rise in the future inflation expectations, which again has seen real US rates move further into negative territory, thereby supporting a non-coupon or dividend paying asset like precious metals.
