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The story in financial markets remained largely the same in recent weeks. Fed's return to QE next week is a certain event. The unknown now is the size and the timing of bond purchases. The Fed has considered a wide range of options. For example, the Fed may start the program by announcing $500B, spanning over several months. It may also purchase $75-100B per month. The plan will be review in every FOMC meeting and should not stop unless economic outlook improves. Economists forecast that the ultimate size of the program will be around $1-2 trillion.
The BOJ brought forward the next meeting to November 4-5 so as to act swiftly after the Fed announces new easing measures. Last week, the BOJ said it would buy corporate debts with lower credit ratings than it previously purchased, including BBB rated corporate bonds and a-2 commercial paper. The central bank would also buy 1.5 trillion yen of government debt, 450B yen in ETFs and 50B yen of REITs.
The RBA, ECB and BOE will also meet next week. While we believe all of them will leave policy rates unchanged, BOE policymakers will continue to dispute whether to expand the asset-buying plan, staying sidelined and begin tightening. In October, policymakers voted 7-1-1 to leave the Bank Rate unchanged at 0.5% and the asset buying program at 200B pounds.
WTI crude oil has been moving within a range of 80-83 in recent weeks. While the dominating factor driving price lower on weekly basis is strength in USD, bigger-than-expected crude oil inventory signaled US slowdown should hurt the fundamentals.
China's National Development and Reform Commission (NDRC) increased retail gasoline and diesel prices by +3%, the first adjustment since June and the first hike since April. Since the new mechanism - price adjustment will be made should international oil benchmarks fluctuate by more than 4% over 22 working days- was introduced in December 2008, only 12 adjustments were made. While we do not expect the price hike would have much impact on end-user demand, it should benefit domestic refiners and reduce export margins for gasoline and diesel.
In September, exports of gasoline increased +5.16% on monthly basis but plunged -23.70% from a year ago. Exports for diesel slipped -7.25% from August but surged +25.31% from the same period last year. After the price hike, exports will remain flat or modestly lower in coming months. However, we do not expect China to return to a net importer of these fuels.
Another good news for Chinese refiners is that the NDRC may release a 'more transparent' oil product pricing mechanism by the end of this year. It's expected, under the new mechanism, fuel prices will be adjusted when international oil prices change 2% in 10 working days. The move would be positive to refiners as domestic fuel prices will move more coherently with international prices.
US natural gas unexpectedly rallied last week with the benchmark contract rising to a 6-week high amid speculations that cooler-than-normal weather in coming weeks would spur demand.
Gas storage gained +71 bcf to 3754 bcf in the week ended October 22. Stocks were -1 bcf below the same period last year and -312 bcf, or +9.1%, above the 5-year average of 3 442 bcf. Separately, Baker Hughes reported that the number of gas rigs added +2 units to 967 units in the week ended October 29.
Gold rebounded strongly on Friday as the dollar slumped after weaker-than-expected US GDP report. The metal's movement has closely tied to currency movements and QE expectations. Therefore, the FOMC meeting next week will be a key for gold's outlook.
The market has fully priced in the Fed will announce new QE measures next week. There have been heated debates on the size and timing of the program. While the majority of economists expect the central bank will need a total of $1-2 trillion for the whole bond-buying program, some believed that the Fed may use a more gradual approach, such as announcing $500B for 6 months or buying $100B per month with re-evaluation of the program on every FOMC meeting. A smaller-than-expected amount will disappoint the market and hurt sentiment. Yet, we believe gold will be less affected than oil and base metals, should there be disappointments. Gold price indeed may rally, after initial selloff, as insufficient QE will probably trigger downgrades in US growth. This could accelerate inflows into gold investments.
Meanwhile, physical demand has provided a cushion for price. According to the Bombay Bullion Association, gold imports to India may exceed 50 metric tons in October. Buying has been driven by the Hindu festival of Diwali on November 5.
Despite a +2.45% gain on weekly basis, gold plunged in 2 out of the last 5 trading days. The correlation between gold prices and the EURUSD has moved firmly into positive territory with rolling 3-month and 1-month correlations reaching 80%. The correlation between the 2 was negative 2 months ago.
The euro was weighed down by renewed sovereign crisis in peripheral European economies last week. The woes resurfaced as the Portuguese government failed to approve a debt-consolidation plan. In other peripheral nations, Greek Finance Minister George Papaconstantinou the country has 'serious tax compliance issues and a review of Greece's 2009 Budget showed the deficit was above +15% of GDP, exceeding previous projections. In Ireland, note holders of Anglo Irish Bank Corp plan to oppose a debt exchange worth 20% of their 1.6B euro of securities. The current situation is different from the one we experienced in May/June when sovereign woes in the Eurozone destroyed confidence in the single currency and spurred demand for safe-haven assets such as USD and precious metals. At that time correlation between gold and USD was temporarily positive while that between gold and EURUSD was negative.
The complex declined last week with losses ranging from 0.89% to 3.54%. While fundamentals remained supportive, concerns over Fed's QE measures damped sentiments and triggered profit-taking from previous long positions.
LME copper for 3-month delivery surged to a 27-month high of 8554 earlier in the week as both JP Morgan and Blackrock will launch physically-backed copper ETFs. However, sky-high price triggered profit-taking and copper tumbled to as low as 8140 before settling at 8220 on Friday.
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