Commodities Weekly: A Year-End Puzzle

A window-dressing by the Longs or investor redemptions after 8 months of historic rally? Year-end activities get farther away from fundamentals as “book-keeping” and “cash-flow” management of Funds hog limelight. This year’s unbelievable rally clouds the case even more. Despite (relative) calm in weekly close this week, many market participants sense volatility rising as we approach towards the year-end. Let’s look at the issue in more detail.

The Year-end puzzle

Managed Funds (popularly known as hedge funds) typically keep a 45-days notice period for investors to notify redemptions. While funds customise rules according to their trading style and liquidity in the market they operate, 45-days is typical standard in this industry. In other words, by mid Nov09, funds would have a clear picture of total year-end redemption requests. On the background of about 60% return from emerging market funds and about 40-50% from commodities funds this year, several investors may like to err on the side of caution and look at new year portfolio allocations afresh. Central banks around the world are gradually gearing towards mopping up “excess cash”; announcements in this regard could pick up momentum early next year. Besides, investors are worried about sliding surprise in corporate results to be announced in January. Markets have clearly run ahead of fundamentals and a rational investor would like to get off before the stampede. Yo-Yo in equities this week indicated that learning from last-year’s experience certain funds are raising cash ratio in their portfolio in order to be ready for upcoming redemptions. While preparing for the redemptions, funds would like the process to be smooth; the needful will be done without rocking the boat.

On the flip side, market participants find several late-comers waiting for dips to get on the board. Stabilising financial markets, encouraging trend of economic data releases (with few exceptions) from most of the countries, falling trend of dollar and low interest rate in US for an “extended period” are creating comfort zone for several funds and investors. Despite the calls for “asset bubbles” and 1970 style inflation in longer-term, many investors find the near-term conditions quite conducive for incremental investments in risky assets.

While both of the above arguments may prove true, it could create good volatility across the asset spectrum. New “smart” money will wait for dips which could be created by redemptions. The test of strength could be an upcoming event. It appears that market mood in the third week of Nov09 could provide a good indication for the likely trend for rest of the year.

The last week

The trend of rising stocks in Shanghai and LME extended further this week with Aluminium and Zinc as exceptions at LME. Aluminium warrant cancellations were seen in US warehouses confirming small waves of re-stocking in the country after almost 3 years of de-stocking. Stocks may continue to rise as Chinese spot demand remain low and metals quite well supplied. Traders reduce inventories in fear of correction in prices. The big question in the physical market is whether the soft spot demand represents seasonality or end of destocking cycle. With every rise in stock and prices holding highs, market’s hypothesis of a “seasonal break” in demand is on tighter test.

This week’s strong economic data from China [PMI], US (factory orders), Europe (New Orders), upbeat assessment from Australia and no indication of rate rise by US Fed were well received by the market. However, the data failed to surprise commodity prices in any big way. Most commodities (except Gold) were consolidating in high ranges and looking for direction. It seems the cross-waves of weak physical, ebbing investment demand in the year-end and yet hopes for economic recovery are driving sentiment mixed.

Metals remained range-bound, but volatilie with US equities and Dollar driving the sentiment. Poor US un-employment report got absorbed quite well as hopes for recovery trending higher in near future continues to drive the investment sentiment. Zinc visited its near-term support of 2150 several times and bounced back while Copper is consolidating below a down-trend line. Steep rise in exchange stocks (3240mt) and expectations of a delayed recovery in Stainless Steel market kept Nickel under check. Indian Central Bank’s purchase of Gold from IMF helped Gold continue its march. Large stock overhang and mixed economic data saw Crude consolidating below $80. Demand for disllitate products in the US was reported at 9 year low; demand in Europe struggles as well. High unemployment and foreclosures have kept consumers in a mood of denial, unlike speculators.

Pains in the Chinese steel sector continue to rise. With steel inventories in major cities almost doubling y-o-y, Chinese Iron and Steel Association expects further fall in domestic steel prices. After Europe, now US has imposed anti-dumping on Chinese steel products with China defending its case. Clearly, oversupplied markets and yet weak domestic industries are raising protectionism across the world. Besides, Chinese over-production has started influencing world prices.

Physical premium

High prices and heavy re-stocking by China earlier this year continues to keep physical activities low key this week. Traders are not confident of pick-up in Chinese demand before new-year (in Feb) next year and hope a correction in prices to help dip-buying. Physical copper demand is seen sliding in most of the developing countries. Good metal availability in China, festive break in India (and high prices) and falling industrial activity in Mid-east has seen demand for Copper cathodes and Rods registering noticeable fall. In Mid-east copper cable consumption is reported to have fallen 30% in last couple of months. Copper warrant premiums continued to remain low two-digit number in Asia.

Tight spot availability due to financing deals keep Zinc and Aluminium well demanded. The premiums held high across the east; Zinc premiums rose slightly in UK and Europe.

Market mood

Given a weak weekly close, we expect copper to drive the base metal complex lower this week. Copper, Nickel and Zinc are consolidating in a flag below down-trendline; jobbing from short side with stop-loss on trendline break-out could be a good strategy to deploy.

Gold seems to have one more positive week before it could enter into consolidation phase. Post this Gold would have completed three waves after the break-out. We would stay away from building any new longs on Gold from next week onwards.

Disclosure: None.