A Light Day for Fundamentals Doesn’t Prevent Gold and Oil Volatility

North American Commodity Update

Commodities - Energy

A Sharp Intraday Recovery from Crude Forestalls a Breakdown

Crude Oil (LS Nymex) - $75.42 // -$0.35 // -0.46%

It’s difficult to justify crude prices at current levels (much less $100 or above) when the outlook for economic output continues to deteriorate and we see extraordinarily bearish supply figures like those reported by the Department of Energy released today. According to the US government body, total petroleum stockpiles ballooned to a more than two-decade high. This fundamental imbalance however is not what defines price. It is market participants and their biases that guide price action. And, while the two often follow the same general trend, there is a near-constant state of divergence in the short-term. However, the discrepancy between prevailing price and underlying market conditions cannot be sustained for long. Eventually, one corrects to meet the other and market conditions are not typically volatile. This is the reason Wednesday’s price action comes across as being exceptionally precarious. An initial drop below the prominent rising trend channel from the past three months was quickly followed by a retracement to maintain the pattern. False breakouts of this magnitude are few and far between; and so should be noted.

For fundamental activity Friday, we can see from intraday price action, that there was a distinct timing in crude’s about face. Up until the open of the US trading session, the commodity was pitched into an accelerated decline. The fundamental push that would contribute to this move was light; and this perhaps opened the door to the reversal. Through the Asian and European sessions, investor confidence (measured through equities) was tilted to a slightly positive bearing. It wasn’t until the US session that we would see something substantial from physical supply-and-demand factors. On the one hand, the DoE inventory figures reported an 818,000 barrel drop in crude holdings and an increase to the highest level of gasoline consumption since August 2008. However, the glut of total petroleum holdings grew to a recent record high and crude specifically is not far from its own 20-year high. The general health of the data cannot be ignored.

Speculators should take note that through the day, CBOE’s volatility index for crude rose as high as 35.7 percent on the initial breakdown but quickly slipped on the recovery to 33.9 percent. Nonetheless, from the futures market, we saw volume on the liquid October contract hit a new record 261,078 contracts and open interest hit levels unseen since the maturity started trading. Taking a bigger perspective look at the overall market, aggregate volume hit its highest level in nearly three months.

Crude Futures Chart (Daily)

Chart generated usingFXCM Strategy Trader

Commodities - Metals

Gold Tests its Former Price Ceiling before Extending its Three Week Run

Spot Gold - $1,229.45 // $4.60 // 0.38%

There was relatively little for fundamental traders to go on when trading risk appetite trends; so we would expect gold (which has diverged from these underlying concerns) to have been particularly listless. On the contrary, the metal would put in for a substantial loss early in the day and eventually recovery the drawdown and more through the close of the New York session. The morning tumble was the not the product of standard sentiment trends as risk was rather tame through. Rather, the initial decline can be attributed to doubts over its value as an alternative asset and safe store of wealth as capital markets stabilize. Its value was further undermined by news that Portugal’s debt sale met significant demand and drew a reasonable yield to suggest European finances were encouraging in general.

This optimism over the fiscal and financial strength was later played down however by the realization that the Greek-German bond spread hit a new multi-month high, Spain was taking steps to skirt an austerity initiative (without being labeled a defector) and news that the Bank of England deferred from curbing its quantitative easing program. Net this puts the stability of the global financial market in the same situation it was in the past weeks – on the road to calamity unless leverage is unwound.

The real source of gold’s strength is more likely the bid found through fund purchases. The SPDR gold index (the largest fund backed by the metal in the world) grew 0.91 tons to 1,295.5 tons and gold funds advanced for a fifth consecutive day. Attempting to get exposure to the market without having to worry about the roll on futures or the carry cost of holding the physical, we have seen in recent years that proxy funds like these are having a greater and greater influence on price action. And when it comes down to it, it is a pretty consistent, bullish pressure. As for volume on the futures market, the December contract hit a four-day high for turnover of 94,837 contracts. Delayed aggregate volume on the other hand slumped to its lowest reading since August 20, 2009 (64,217 contracts) – a situation that creates a major weight on price action.

Spot Silver - $18.37 // -$0.15 // -0.81%

Silver would see a sharp intraday decline Wednesday; but the severity of the loss would be eased through the US close. Despite the decline though, the metal remains very close to its range high seen at approximately $18.70/50. Futures traders noted a sharp drop in volume across the maturity spectrum for the commodity. The active September contract saw a jump in turnover to 48,818 contracts – a record since it started actively trading.

Spot Gold Chart (Daily)

Chart generated usingFXCM Strategy Trader

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Written by John Kicklighter, Strategist

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