The Definitive Shift in Risk Appetite Weighs Crude and Stocks Alike
North American Commodity Update
Commodities - Energy
The Definitive Shift in Risk Appetite Weighs Crude and Stocks Alike
Crude Oil (LS NYMEX) - $75.81 // -$0.81 // -1.06%
While US crude put in for a moderate decline Friday (the third consecutive contraction) it is a fair fundamental assessment to suggest that the bearish move was far more reserved than what is justifiable. From the recent peak in the market’s upswing, the active Nymex crude futures contract has slipped only 2.7 percent. For comparison, the S&P 500 plunged 2.9 percent just through Friday’s active session. Looking at the mechanics to this relatively stable performance, there is nary an argument to be made from either speculative interest or essential demand to prevent a much deeper and lasting correction. Establishing the situation for today alone, we were confronted with influential economic data that would significantly undermine expectations for growth (and thereby energy demand) in the world’s largest economy while investor confidence potentially snuffed out its opportunity to stage a lasting recovery.
The most prominent fundamental driver for the day was the University of Michigan’s consumer sentiment survey for the month of July. This indicator defines the confidence of a group whose spending accounts for 70 percent of output for the world’s largest economy. Thereby, this single data point can easily be interpreted as an early warning for the performance of the US economy in the months ahead. And, in this role, the report can be construed as both a measure of actual energy consumption going forward (through Americans’ refined fuel needs and the production resource costs for producing goods) and an upstream measure of risk appetite. The 66.5 reading made its mark with the worst level in a year and the biggest month-over-month drop in 21 months. With three out of four respondents expecting the employment condition to deteriorate in the coming 12 months and the expectations component of the survey falling to its lowest point since March of 2008, it isn’t difficult to trace sentiment back to the labor market and dour outlook for a recovery. Naturally, this would in turn feed the steady decline in investor optimism on the day; but it should be noted that the worst of the deterioration on the day occurred well before this official release. This was partly due to the questionable numbers from key earnings US bank earnings reports; but it is also likely a consequence of the ill-supported climb in speculative interests in the preceding week.
Looking ahead to next week, the discussion over the world’s economic activity level will continue. Of particular interest for those fundamental energy traders trying to find a bead on the demand/supply balance, the second quarter GDP report for the United Kingdom will be of particular importance. Not only is it one of the world’s largest importers of petroleum products; the health of this economy will set a precedence for the developed world (where the Chinese growth update was a proxy for the developing world). That being said, risk appetite holds the greatest potential for price action. Aside from a few road bumps along the way, the results for the EU stress tests due Friday threaten to dramatically alter investors’ perception of the market terrain.
Traders should note that volume on the September Nymex crude futures contract (the August contract expires on the 20th and liquidity is already rolling out to the next deferred) slipped for the first time in five days despite the greater level of background noise. Further, the CFTC’s COT statistics for the week ending July 13th show net speculative long interest in the market grew 32 percent to 34,645 contracts. That being said, the actual change in the number of contracts is far smaller than swings in January, February, March, May and June.
Commodities - Metals
Traditional Risk Trends Don’t Bolster Gold’s Safe Haven Status, Sovereign and Structural Concerns Do
Spot Gold - $1,193.00 // -$15.25 // -1.26%
Gold’s performance for the day would seem yet another contradiction to fundamental expectations. Risk appetite marked a dramatic tumble through Friday’s session – dragging most growth-linked assets along for the ride – and yet the supposed safe haven commodity was itself pitched in a sharp decline. In fact, the 1.7 percent drop in the Comex-based active gold futures contract (spot closed the session down 1.3 percent) was the worst single-day loss since the dramatic collapse on July 1st. And, drawing another contrast between these two instances of bearish activity, both marked a clear reversal effort on a steady advancing trend. The notable difference between the two was that this most recent decline was a correction in much smaller trend. Performance aside, the direction likely struck many traders as highly unusual given the metal’s usual, negative correlation with risk appetite trends. It is true that gold is a safe haven commodity; but it is not prone to the dramatic swings that other liquid assets classes exhibit as this particular commodity acts as a safety net to a very specific concern: structural uncertainty.
Rather than simply standing as a short-term alternative to long-biased stocks, gold is considered an alternative store of wealth that better weathers big swings in sentiment itself while also offering a buffer to underlying stability concerns. Of particular interest over the past weeks and months has been the European area’s financial health. Conditions seemed to be improving as successful government bond auctions indicated an ability to access the capital markets; but the cost associated to this financing activity reflects the true situation. As the pace of the economic recovery levels off and perhaps recedes in the coming months, the strained EU members may be pushed into dire conditions. What’s more, this general trend will weaken the strength of top performers and could perhaps push some regions into trouble (such as China facing a credit problem). These are structural concerns that falls outside the normal diversification abilities of market participants. In reality, this commodity will not be able to fully divorce itself from such overwhelming issues; but it will do better than most.
Isolating today’s performance, gold plunged in the span of just 20 minutes before the opening bell of the New York session. Given the timing; it is reasonable to link price action to the earnings figures that preceded the start of US trading. Considering equities were themselves on the decline, how do we reconcile the precious metal’s performance? The drop in other capital markets no doubt led to substantial losses in portfolios; and a need for margin and preserving cash reserves would likely lead to an unwinding in gold exposure. Looking ahead to next week, the EU’s stress test results could lead to even greater confusion between a requirement for cash and the need for an alternative asset. Regardless of what role wins out, it promises to be an interest week.
Spot Silver - $17.85 // -$0.49 // -2.65%
Finally shaking congestion, a strong decline pushed silver from a steady but gradually advancing trend channel Friday. Considering speculative interests, gold and industrial metals all fell on the day, silver would find no support for a counter-market move. As for measuring trading activity, volume on the September futures contract on the Comex rose to its highest level of turnover in two weeks; while the CFCT’s commitment of traders’ figures reported little change in net long speculative interest (it currently stands at 35,182 contracts).
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Written by John Kicklighter, Strategist
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