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A Rally for Equities and Tumble for the Dollar Encourages the Biggest Crude Rally in Two Weeks

A Rally for Equities and Tumble for the Dollar Encourages the Biggest Crude Rally in Two Weeks

2010-07-13 23:09:00
John Kicklighter, Chief Currency Strategist
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North American Commodity Update

Commodities - Energy

A Rally for Equities and Tumble for the Dollar Encourages the Biggest Crude Rally in Two Weeks

Crude Oil (LS NYMEX) - $77.15 // $2.20 // 2.94%

Given the clear boost in risk appetite across the capital markets Tuesday, oil’s rally should come as little surprise to the experienced trader. Falling back on its speculative roots, the commodity would take its cues from the positive sentiment that drove the S&P 500 up 1.5 percent to a three-week high. On the other side of that equation, the safe haven US dollar (which further happens to be the primary pricing tool for oil) would itself slip to a two month high. Naturally, the appetite for risk – and the yield that comes with it – would push the active New York-based crude futures contract beyond $76.50 and on to a two-week high all on its own. That being said, doubt remains with the conviction behind the current bull phase. Volume is not yet showing support for the recovery effort. In fact, the rolling weekly average of aggregate volume has steadily decline through April, May, June and now into July. Currently the average daily turnover stands around 537,000. On the other hand, net open interest (the total of the various NYMEX futures contracts) has slowly appreciated over the past two weeks alongside the underlying advance in price.

Fuel for the advance in risk appetite can be traced back to a specific event. Through the Asian session, sentiment was still under pressure after China reaffirmed its policy to curb lending and speculative activity in the housing market; and the BoJ reported the nation’s pension fund had sold government debt for the first time in nine years. Heading into the European session, most scheduled event risk would have supported uncertainty and risk aversion. European investor sentiment slipped to a 15-month low and confidence in the fiscal stability of the European region was undermined by Moody’s downgrade of Portugal’s sovereign credit rating. However, the focus was instead exacted on the news that Greece’s bond sale had met relative success. Further developing the questionable optimism this announcement had introduced, the US earnings session seemed to start off on a positive note with a better than expected report from Alcoa. From the markets’ reaction to this news, it would seem that the coast is clear; but that is certainly not the case.

Further complicating the situation for crude’s advance, supply and consumption figures would offer a mixed picture for the equilibrium price over the coming weeks and months. Setting up expectations for tomorrow’s weekly Department of Energy inventory figures, the American Petroleum Institute’s crude stockpile report for the week ending July 9th grew 1.74 mln barrels following the biggest drop since September 2008. Tomorrow’s government report is expected to print a 1.5 million barrel increase in holdings along with a hold in the utilization rate at 89.9 percent (the highest level since January 2008). Another interest reflection on production from API was the assessment that US oil and natural gas drilling in the second quarter grew 38 percent from the same period a year ago. As long as this expansion in output is sustained, pressure will remain on prices. This is especially should the International Energy Agency’s (IEA) forecast for consumption prove accurate. According to the group, daily demand in 2011 will rise only 1.3 million barrels or 1.6 percent to 87.8 million barrels – a cooler pace of growth than the previous year. This temperance comes through increased efficiency, the OECD nations’ move away from oil and a withdrawal of stimulus worldwide to support growth.

COM-10-07-13-01

Commodities - Metals

Both Gold and Risk Appetite Advance but Not Because of an Realignment of Functions

Spot Gold - $1,212.35 // $15.50 // 1.30%

It would seem that gold has abandoned its role as a safe haven and is now taking its direction from risk appetite. On the surface of things, gold put in for its biggest single-day advance in three weeks while the equities market (the traditional investor asset) put in for its own impressive climb. However, this simple connection is more a happenstance than a direct correlation. The difference is that this correlation is transient and will almost certainly dissipate in the near future. So, why would the metal and stocks head in the same direction and move at the same clip? Equities were encouraged by the selective assessment that Greece’s bond auction was a reflection of health for the European financial system and the Alcoa earnings report signaled a strong second quarter for American firms. If we were to hold with the recent role that the precious metal has played in the financial markets, we would be led to believe that this collective improvement would be grounds for depressed speculative instruments to recover ground and encourage investment. Gold is certainly not depressed and the collective interest behind the asset would actually be conducive to drawing capital out.

It is easy to simply interpret gold’s rally to be a product of this development; but in fact there were very clear catalysts for its own performance. While the speculative crowd at large was preoccupied by the lower than expected yield on the 26-week Greek bond auction and the higher than expected bid-to-cover; those looking at the bigger picture were more concerned with the momentum in the European financial market’s deterioration. The cost of this bond auction was still prohibitively high and Greece is still overburden financially; but the hypersensitivity to important developments offers a false sense of strength. Far more interesting to grounded market participants was the news that Portugal would have its sovereign credit rating cut by Moody’s. The nation was on watch for some months now; so the cut is not out of the blue. On the other hand, the slow motion crash that is developing is further spelled out by this move. What’s more, with the Stress Test results coming due next week, we are already finding skepticism plague expectations. Should the results be doctored or incomplete, the reaction could naturally defer to the negative. As for earnings, the financial group’s performance is far more important to assess the bigger situation. That being said, deferring losses is a well-known solution for firms looking to bolster their figures.

Spot Silver - $18.25 // $0.29 // 1.62%

Whether silver was taking its guidance from gold or risk appetite, the result was the same. The metal put in for its biggest rally since June 25th. That begin said, technical traders would note that the metal is still set within a gradual, rising trend channel. Looking at interest through the futures market, aggregate volume has held over the past few active trade days at its lowest level since December. At the same time, open interest dipped to its lowest level since May 7th.

COM-10-07-13-02

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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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