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A Shift in the Taste for Risk Sends Crude into the Next Phase of a Bigger Bear Trend

A Shift in the Taste for Risk Sends Crude into the Next Phase of a Bigger Bear Trend

2010-05-14 22:04:00
John Kicklighter, Chief Currency Strategist

North American Commodity Update

Commodities - Energy

A Shift in the Taste for Risk Sends Crude into the Next Phase of a Bigger Bear Trend

Crude Oil (LS NYMEX) -  $71.95   //  -$2.45   //  -3.29%
At the moment sentiment starts breaking down in the speculative markets, investors’ attention focuses on their portfolios, looking to lighten up on those positions that will fall alongside optimism. Crude is one of those assets that has built a strong attachment to risk appetite over the years as portfolio diversification has shifted to include commodities and along with an increased accessibility in the form of ETFs. Naturally, with the return of concerns that the European Union will fail in its efforts to bailout Greece (and those other member dominos that are at risk of falling into a fiscal vortex once this leaky ship finally sinks), risk appetite has once again fallen across the board. In turn, this has translated into a push to fresh yearly highs for the safe haven dollar, a sharp loss for US and especially European equities, and another aggressive tumble for the benchmark NYMEX crude futures contract. Friday’s was the fourth consecutive decline for oil and the sharpest this week. The bearish performance through the close may not statistically measure up to the stark declines in the string through last week; but this finishing gasp has larger meaning. With this drop, the market has marked an unfavorable break from a channel that has defined this commodity’s trend since the recovery from the last financial crisis began. In the span of two weeks, oil has collapsed 17 percent; and with technicals now joining fundamentals in abandoning support, we may be looking at the development of a new and lasting trend.
However, there are crude bulls out there that claim that the current decline is merely a retracement that will soon curb as speculative risk premium is fully worked off. What this notion fails to account for is the fact that financial crises (fears of which are at the root of this speculative freefall) have a tangible impact on the economy. What started out as the subprime crisis in the United States would mutate into a global credit crisis that further caused what is now termed the “Great Recession.” Panic, uncertainty and the lack of funds will curb employment, lending, investment and other vital components to expansion. And, considering the world is still attempting to recovery from the last shock, the impact of a second round could prove more permanent on the economy (i.e. no rapid recovery). The chance of a European Union-born crisis is at the top of the lists for concerns as it already looks like a number of the group’s members will be pitched back into recession just to comply with the leadership’s requisite deficit cuts. However, it should be said that this region is not the only threat to the global stability and prosperity. China and the emerging market economies were able to survive the last plunge; but now we see their markets and economies have overheated and the foreign demand has been severely slowed. Then, there is the sovereign credit health of the world’s industrial giants. Downgrades for these engines of activity could be another clamp on capital and thereby growth. The risks to growth are immense; but it will always depend on whether the market is aware of them.
Commodities - Metals

Renewed EU Concerns Don’t Translate into Fresh Gold Gains

Spot Gold -  $1,231.30  //  -$1.40  //  -0.11%
The European Union situation has gone through various stages this past week. First the 750 billion euro bailout plan spark optimism that the region and members would stabilize and find prosperity. The day after the news was processed, doubts started to seep in. Finally, on Friday, skepticism would once again crowd out the paper promises of an essentially unlimited credit line. Fear was stoked by news that that French President Nicholas Sarkozy had to threaten German Chancellor Angela Merkel with pulling his nation out of the Euro Zone in order to bring the group’s largest economy to the table for a bailout. While this may not have been a genuine threat, it tells us of the fractitious nature of the Union and the difficult that will no doubt be found in actually administrating the rescue program – as funds will almost certainly be used. On this news, a withdrawal from risky assets would push equities into steep declines and lead the safe haven dollar to new yearly highs. Yet, for gold – which is not only seen as a store of safety but as an alternative to currencies at jeopardy from sovereign credit downgrades – the worries would not produce an advance. In fact, the metal would spend tumble on the day after retesting Wednesday’s record high. Does financial crisis no longer hold the same threat to speculative endeavors and market structure? Of course not. However, there is a cost to holding gold. While it can certainly be considered an alternative currency, it is already very expensive and naturally prone to thin liquidity. What do these conditions mean? If there is a transfer back into fiat assets down the line, it wouldn’t take a very large sell order to produce a steep decline in the commodity’s value.
Spot Silver  -  $19.30   //  -$0.13  //  -0.67%
It seems silver’s correlation to gold has grown far stronger with both metals trading near record highs. Typically, the speculative response to EU bailout concerns with equities tumbling and the benchmark dollar rallying would translate into a selloff for this market. However, with the more expensive metal stalling in its own advance, silver will not be able to resist the tide for long.
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Written by John Kicklighter, Strategist
Questions or Comments about this article? Send them to jkicklighter@dailyfx.com

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