Risk Appetite Diminishes amid Worries about Capital Controls

Investors continued to unwind long positions in risk assets after QE mania has sent prices much higher. USD soared as criticism from China and Germany on Fed's QE2 persisted ahead of the G20 summit, heightening worries about a discord among member countries. Commodities traded with high volatility. WTI crude oil initially surged to 87.63 as both the IEA and EIA raised their global demand forecasts. Gains were erased as the dollar firmed and equities slipped. Price eventually settled at 86.72, down -0.39%. Gold initially rallied to a new record high of 1424.3 but strength in USD and a silver-led selloff sent price to as low as 1382.2 before finishing the day at 1410.1, up +0.49%. Today in Asia, corrections continued and commodities were generally lower.

Risk appetite reversed as geopolitical tensions intensified ahead of the G20 meeting this week in South Korea. World Bank's comments heated up concerns over capital controls in emerging markets. Sri Mulyani Indrawati, a World Bank managing director, said 'certain assets will become, potentially, bubbles' and 'the quantitative easing will create a lot of liquidity flooding to the East Asia Pacific region, because it is the most dynamic and attractive with a higher return on investment'. She advised these economies target temporary curbs to address these problems. Indeed, China has stepped up measures to control excessive inflows.The State Administration of Foreign Exchange said it will tighten management of banks' foreign-debt quotas and introduce new rules on their currency provisioning. The government will also regulate Chinese special-purpose vehicles overseas and tighten controls on equity investments by foreign companies in China. Taiwan also said it will limit foreign ownership in the island's debt.

China, facing pressures from the US on RMB appreciation, criticized on Fed's easing measures. Chinese officials have raised worries about Fed's $600B plan since the FOMC meeting last week. PBOC adviser Xia Bin said the plan is 'uncontrolled' money printing, Vice Finance Minister Zhu Guangyao said the program could 'shock' emerging markets by flooding them with capital and Vice Foreign Minister Cui Tiankai stated 'many countries are worried about the impact of the policy on their economies...It would be appropriate for someone to step forward and give us an explanation, otherwise international confidence in the recovery and growth of the global economy might be hurt'. China's Dagong Global Credit Rating Company yesterday reduced its credit rating for the US to A+, from AA, with a 'negative' credit outlook. The rating agency said Fed's QE reflects the country's 'deteriorating debt repayment capability and drastic decline of the government's intention of debt repayment'. While we do not think Dagong's decision would affect US' rating in mainstream credit rating agencies, the act evidenced the spat between China the US.

Germany's Chancellor Merkel defended Germany's trade surplus, saying 'trade balances are also indicators of performance; they're the results of global market processes'. She added 'policy that aims for an artificially devalued currency and the associated export advantages is shortsighted and in the end hurts everybody...It can't be that such developments lead to a stable currency such as the euro bearing the adjustment burden'. Merkel's comments signaled conflicting natures among G20 leaders.

Commodity price movements have been directed by macroeconomic outlook with fundamentals taking a backseat. The US Energy Department raised its global oil demand forecasts to 86.33M bpd (from 86.06M bpd) for 2010 and 87.77M bpd (from 87.44M bpd) for 2011. Main drivers for the upgrades are stronger-than-expected growth in European oil demand during 2Q10 and 3Q10, and continued strong growth in China. In 2011, non-OECD regions, especially China, the Middle East, and Brazil, will contribute most of the expected growth in world oil consumption while the US and Canada will show almost all the oil consumption growth for OECD regions.

Meanwhile, the International Energy Agency forecasts global power demand will increase +2.2% every year 2008 through 2035 with China and other emerging countries representing most of the growth. China will also overtake the US as the largest user of electricity by 2012.

After market close, the industry-sponsored API reported a -7.4 mmb draw in crude oil inventory in the week ended November 5. Gasoline and distillate also recorded drops of more than -3 mmb during the week. The market expects official data from the US Energy Department will show gains in crude inventory but declines in gasoline and distillate stockpiles.

Weekly change in inventory as of 05/11/10

Comparison between API and EIA reports: Forecast (using API's inventory level)

API collects stockpile information on a voluntary basis from operators of refineries, 76% of the time, using data in the past 4 years.

Source: Bloomberg, API, EIA

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