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Market's focus shifted from Fed's QE2 to G20 currency and trade tensions, and then to possible bailouts of peripheral European economies by the EU. Robust macroeconomic data in China initially boosted market sentiment and drove growth asset prices higher. However, speculations that the government will accelerate tightening measures by raising interest rates dampened risk appetite.
The dollar rebounded across the board as financial leaders and economists from around the world criticized US' easing measures. Moreover, CDS and yield spreads between peripheral European bonds and German bunds widened sharply, signaling sovereign concerns in these countries were once again put under the spotlight. G20 leaders' deep discussion about the issue evidenced seriousness of the situation.
In response to US President Obama's criticism that China has spent 'enormous amounts of money intervening in the market' to keep RMB 'undervalued', China's President Hu Jintao reaffirmed that the country will 'continue to improve its currency reform at a steady pace'. It will also balance the trade gap by 'boosting domestic demand'. In our opinion, the G20 meeting failed to resolve international trade imbalances. Despite the pledge to work on 'indicative guidelines' to avoid sustained current-account imbalances that require preventive and corrective actions to be taken, the lack of actionable clarity suggests that individual countries will continue to use their own ways to achieve their goals.
WTI crude oil climbed higher earlier in the week and rallied to a new 2-year high of 88.63 Thursday as a surprising decline in petroleum inventories and stronger-than-expected Chinese macroeconomic data boosted sentiment. Upgrades in global oil consumption by EIA, OPEC and IEA also sent oil prices higher. However, gains were erased amid intensified sovereign concerns in peripheral European economies and increasing possibility of a rate hike in China. The front-month WTI contract tumbled to 84.52, the lowest level in a week, before settling at 84.88 on Friday.
Major oil agencies raised their forecasts on global oil demand for 2010 and 2011, as growth in OECD consumption exceeded expectations after 1Q10. Taking an average from the forecasts made by EIA, OPEC and IEA, global oil demand will increase +2.33% y/y to 86.48M bpd in 2010, followed by a +1.44% gain to 87.72M bpd in 2011. To meet the rises in demand, supplies from both non-OPEC and OPEC countries will have to increase.
OPEC's 11 members bearing quotas produced 26.89M bpd, the highest level since December 2008, with compliance falling to 51.3% in October. While oil ministers have urged member countries to adhere more strictly to quotas (OPEC - 11 to produce no more than 24.845M bpd), many of them produce excessively so as to benefit from recent rally in oil prices. Similarly, IEA also estimated a modest drop in compliance to 55% in October from 56% a month ago.
Among the OPEC-11, Saudi Arabia, UAE and Kuwait produced with highest compliance while Nigeria and Angola exceeded their implicit quotas the most. Nigeria and Angola have argued that their quotas were assigned based on low production levels when the countries were having either operational problems or militant activities.
Although monetary tightening may curb commodity consumptions, other measures from China may help boost oil prices. The Chinese government's control on power supply has led factories to using their own power generations. According to the National Bureau of Statistics, China's oil processing in October rose +12% y/y 8.8 M bpd. Meanwhile, there are increasing expectations that China may return to a net importer of diesel after being a net exporter since October 2008. Indeed, China's net exports of diesel fell for a second consecutive month to 55K bpd in September.
Seasonally, China's demand for liquid fuels is typically the strongest in the second and third quarters. The pickup in demand in coming month as a result of governmental policy may tighten the supply outlook in 4Q which is usually a peak demand season for the US and Europe.
Gas price tumbled as US storage surged to a record high last week. According to the US Energy Department, gas stocks rose +19 bcf to 3840 bcf in the week ended November 5. Supplies were +31 bcf higher the same period last year and +342 bcf, or +9.8%, above the 5-year average of 3498 bcf. Separately, Baker Hughes reported that gas rig counts stayed unchanged at 955 units in the week ended November 12.
In its Short-term Energy Report, the EIA forecast that total natural gas consumption will grow by +4.3% to 65 bcf/day in 2010, followed by a modest rise to 65.4 bcf/day in 2011. The growth in 2010 is largely due to 'increases in industrial and electric power sector consumption of natural gas. Hot weather in the summer and low natural gas prices drove the increased use of natural gas for electric power generation in 2010'. However, natural gas consumption for electric power generation will fall slightly in 2011, even as natural gas prices drop, due to a drop in cooling-degree days. Residential consumption of natural gas, which remains flat from 2009 to 2010, will rise +1.8% in 2011. Commercial and residential consumption will remain flat in 2010 and rise slightly in 2011. Meanwhile, the EIA revised up its production forecasts for 2010 and 2011.However, drilling activities will fall modestly in 2011 because of relatively lower natural gas prices.
Rising inflationary concerns, renewed sovereign concerns and strong Asian buying sent gold to fresh record highs and silver to new 30-year highs. While it takes time for the Fed to bring inflation back to levels that are consistent with its mandate, the return to QE have driven enormous capitals to countries with higher yields. Emerging countries such as China and South Korea are expected to record higher CPI in coming months. Indeed, capital inflows in China have been surging despite Government's tightening measures. China's CPI surged +4.4% y/y in October, beating market expectations of +4% and September's +3.6%, as driven by rental and cotton prices. New lending reached RMB 588B, compared with market expectation of RMB 450 B. It's likely that annual lending will reach RMB 8 trillion, exceeding the government target of RMB 7.5 trillion. Other data, such as IP, fixed asset investment and retail sales, expanded in annual terms but came inline with market forecasts. Stubbornly-high inflation and net loans triggered the PBOC to raise RRR by 50 bps. We expect inflation will rise further in November and the government will need to accelerate measures to curb potential asset bubbles.
Although ease in European sovereign triggered selloff in gold price last Friday, uncertainty remains and should lend support to the metal. As the Fed provide more liquidity to boost economic growth, the more the euro will strengthen against the dollar. Appreciation in the single currency is precarious for growth and prolongs the recovery process. We believe the impact will be more serious on debt-ridden countries.
Gold and silver correlations with EURUSD have fallen sharply over the past week, suggesting euro's weakness because of sovereign concerns may not necessarily weigh on precious metal prices. Indeed, investors may turn to these metals as safe-haven assets as they lose confidence in fiat currencies.
Indian festival Diwali officially began on November 5. The festival typically indicates the seasonal peak in Indian gold buying. According to the Bombay Bullion Association, gold imports jumped +25% y/y during the festival week despite elevated prices.
Similar to others in the commodity sector, base metals soared on strong Chinese industrial production data. Prices tumbled on Friday amid speculations that China's central bank will raise interest rates to curb inflation.
Copper traded with high volatility with the LME contract rising to a new record high of 8966 on Thursday before settling at 8615 on Friday.
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