Risk-Off Trades Dominate. Commodities Slump as USD Strengthens

ONG Focus | Insights | Written by Oil N' Gold | Wed Oct 27 10 07:50 ET

Risk appetite remained weak in European session amid concerns about 'measured QE' policies. The dollar strengthened while growth currencies and other risk assets plunged. Aussie tumbled as inflation missed expectations. Focus in the US session will be on durable goods orders, new home sales and oil inventory data. Commodities fell across the board. The front-month contract for WTI crude oil slipped below 82 ahead of official oil inventory report. Precious metals and base metals also slumped on profit-taking.

The Wall Street Journal said that the Fed will likely announce a bond-purchase program, worth a few hundred billion dollar spanning over several months, at the FOMC next week. The amount would be significantly lower than market expectations of at least $500B over 5 months. Investors took profits from previous 'short-USD' trades as the selloff was probably over-extended with such a 'small' amount of QE.

Currently trading at 0.9715, Australian dollar plummeted for a second day against the dollar as CPI surprisingly eased to +2.8% y/y in 3Q10 from +3.1% a quarter ago. This may prolong RBA's pause in tightening. Other commodity currencies, New Zealand and Canadian dollars also fell. The RBNZ will leave the official cash rate (OCR) unchanged at 3% for a second month at today's meeting. The accompanying statement will also be dovish as led by disappointments from GDP growth and retail sales. Policymakers would reiterate that 'the pace and extent of further OCR increases is likely to be more moderate' that previously anticipated.

The base metal complex has been a bright spot in recent months with copper's rally probably the most eye-catching. LME copper for 3-month delivery has risen for 4 consecutive months since July and accumulated about +30% gains since then. The major reasons buoying the price are robust Chinese demand, quantitative easing outlooks, weakness in USD and expectations of launch of physically-backed ETFs. We believe the last 2 were factors driving the rise to recent highs.

Besides JP Morgan, BlackRock has also planned to issue an ETF backed by copper. According to filing documents, each share in the iShares Copper Trust will represent 10kg of copper. It is expected these investment instruments should send prices higher. However, the impact may only be temporary.

Take copper as an example. Supply tightness is evidenced by low inventory levels and mine production problems. It's not unlikely that ETF issuers will acquire the metal from producers. Rather, they will source from LME house, thus, exacerbating the decline in LME stock. In this case, copper price will be boosted initially but higher copper price will trigger sales of scrap copper and demand for substitution. Eventually, copper price will again fall from the peak.

 

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