Commodity Markets

When analyzing commodity markets four main themes come to mind: 1. Default imminent.

James Fournier 17/12/2011

From the quantitative data coming from global bond markets, the simple facts are easily visible ---> default is imminent with both European and Non-European nations entering a stage of debt un-sustainability. The main areas to focus on as this global crisis matures is debt sustainability. When a nations debts become many multiples of central government revenues, a non linear relationship develops that becomes insurmountable because expenses grow faster than revenues even in inflationary or growth environments. Looking at the dry statistics, the debts of the following nations, among others, are not sustainable in the current economic environment: Greece, Italy, Ireland, Japan, Spain, Belgium, Portugal, France. The United States is quickly approaching the zone of insolvency but could avoid it with massive spending cuts and severe reductions in entitlements into the future - yet using historical politics as a measure I wouldnt be holding my breath. Following this grounding, global recessions are highly likely with global financial institutions taking large write-downs on their ownership of government debt. As such, investors looking to take advantage of commodity price movements should aim at further risk-off moves with bearish bets on growth cyclical commodities such as oil and copper. 2. A soft landing in China? It is hard to obtain good data out of China, but something is wrong in the Chinese Economy when the country's Homelink property website can report that new home prices in Beijing fell 35pc in November from the month before. If this is remotely true, the calibrated soft-landing intended by Chinese authorities has gone badly wrong and risks are likely to be spinning out of control. Chinese stocks are flashing warning signs. The Shanghai index has fallen 30pc since May. It is off 60pc from its peak in 2008, almost as much in real terms as Wall Street from 1929 to 1933. According to Albert Edwards at Societe Generale investors are massively underestimating the risk of a hard-landing in China, and indeed other BRICS (Brazil, Russia, India, China).... a 'Bloody Ridiculous Investment Concept' in my view." Fitch Ratings warn that China is hooked on credit, but deriving ever less punch from each dose. An extra dollar in loans increased GDP by $0.77 in 2007. It is $0.44 in 2011. According to China analyst Charlene Chu "the reality is that China's economy today requires significantly more financing to achieve the same level of growth as in the past." Ms Chu warns that there has been a "massive build-up in leverage" and fears a "fundamental, structural erosion" in the banking system that differs from past downturns. Indeed, for the first time, a large number of Chinese banks are beginning to face cash pressures. And yet amongst all this boom and gloom, BRIC and China enthusiast Jim ONeill in closing his latest viewpoint states that China wont have any kind of landing in reality, neither hard nor soft, but it will still be travelling. It might have seemed like a soft one though. One has to ask, is this truly his economic view or is this just PR for his recent BRIC focused book launch The Growth Map. 3. US Dollar strength. Broad based USD dollar strength has been observed in the last few months with the green-back appreciating relative to its major forex counter-parties. When looking at investor sentiment regarding the green-back its helpful to look at the PowerShares DB USD Index Bullish ETF (Ticker: UUP).

James Fournier 17/12/2011 UUP has endured an arduous downtrend over the past two years as the U.S. dollar has faced numerous headwinds in currency market. Nonetheless, recent uncertainty stemming from the deficit drama at home coupled with worrisome Euro zone debt woes have paved the way higher for the greenback. The U.S. dollar has taken on safe haven appeal in recent months as volatile trading across equity markets and an ugly debt crisis overseas have sent investors running for safety. UUP is now back above its 200-day moving average and appears poised to move higher, seeing as how it has managed to close above resistance at the $22.50 level for the last two days. In the near-term if U.S. CPI comes in worse-than-expected, equity markets could face selling pressures as the U.S. dollar takes on safe haven appeal. Indeed, in the long-run, the UUP may continue its trek higher and head towards $22.75 a share. On the other hand, if U.S. CPI paints a bullish picture, a stock market rally may put a damper on the dollars recent run-up. In terms of downside, UUP could fall back to $22.25 a share, although investors should note that the next level of major support lies at $22 a share. With such usd-dollar strength, dollar dominated commodity markets are likely to see downward pressure and as such further paint a negative picture for commodities. 4. ETF Liquidation On a final note, the commodity markets have been incredibly fragmented recently with ETF liquidations occurring as hedge funds and investment managers cash out their commodity bets in part due to a liquidity squeeze but also as they return cash to investors as we finish what has been from a financial market perspective a fascinating 2011.

Global Oil Markets

Fundamental Picture: Crude fell this week, capping the biggest weekly decline since September, on concern that European economic growth will slow, curbing fuel demand. Indeed, OPEC recently decided to increase its production ceiling to 30 million barrels a day, the first change in three years, moving the groups target nearer to current output as it grapples with rising exports from post-war Libya. From a simple supply vs demand picture, this point very bearishly. Yet, JP Morgan has maintained its price projection of $115 a barrel for Brent crude oil, and $97.50 a barrel for WTI through 2012. Earlier this week, Goldman Sachs cut its 2012 Brent crude oil price forecast, on growing worries that the European financial crisis would restrain economic growth and curb global fuel demand. Goldman Sachs trimmed its 2012 Brent oil price estimate to $120 a barrel from $130 and cut its forecast for US WTI crude oil price to $109 from $123.50. The industry average prediction for Brent remains at $106.80 a barrel expected in 2012. Technical Picture: Downward sloping trend channel with a short-run pennant breakout.

From a technical perspective, it looks as if Oil markets for the moment have topped out with the creation of a three tag upper trend channel. Indeed, with the continued fears out of Europe and increased production from OPEC investors should favor the downside, with a classic trade possible off a retest of the highs or $95 or $97 areas. However firm support is likely to be found at the $90 level (marked in blue). As ever, Oil markets remain difficult to predict on a long run basis as described by legendary investor Jim Rogers If Spain goes bankrupt, then oil will go to 50. If Iran and Israel go to war tomorrow, it will to go 200 straightaway. It depends on what happens in current events looking around the world, but basically, as the shortage of crude oil gets worse and worse the price will go much higher. Indeed, it is highly likely that we could see range trading of Oil into the new year.

Gold Markets

James Fournier 17/12/2011

As we look at Gold, we have to ask whether Gold still remains a safe-haven asset. Indeed, this year the gold trade has become incredible crowded and it is worth wondering whether a combination of profit taking, dollar strength and a technical break of the long run vs short run pennant has sullied its safe haven identity. Certainly when the current debt crisis further erupts, it would be unwise to have gold positions in the futures market. The gold futures market will likely seize up, as there will be more outstanding futures contracts than available gold. People who thought they own gold will instead find they own pieces of paper. Physical possession is more likely a safer bet. Looking to the long run, will European countries in 2012 be selling their gold reserves to combat the rising cost of national debt and remain solvent? Indeed, Gold closed this week below its 200 day moving average. Historically, whenever the gold market has crossed the 200 day moving average it has almost immediately retaken the ground. However if Gold fails to do so, this could signal a shift in the way investors think about Gold and its role in global financial markets. Further examining the demand from China and India, its solidity is beginning to be questioned as a landing hard or soft as well as a bursting of the Chinese real estate bubble will impact how BRIC consumers use their incomes.

Soft Commodity Markets - DB Agriculture Index Commodities.

From a technical perspective, soft commodities looks oversold and present a rare opportunity. To take a position against a basket of commodities, I suggest the use of the Powershares DB Agriculture Fund which comprises the following weighting: Base Weight (%) DB Agriculture Index Commodities Corn - 12.50 Soybeans - 12.50 Sugar - 12.50 Live Cattle - 12.50 Cocoa - 11.11 Coffee - 11.11 Lean Hogs - 8.33 Wheat - 6.25 Kansas Wheat - 6.25 Feeder Cattle - 4.17 Cotton - 2.78

Technical Picture: Falling Wedge Pattern (Bullish Reversal).

James Fournier 17/12/2011

The falling wedge is a bullish pattern that begins wide at the top and contracts as prices move lower. This price action forms a cone that slopes down as the reaction highs and reaction lows converge. In contrast to symmetrical triangles, which have no definitive slope and no bias, falling wedges definitely slope down and have a bullish bias. However, this bullish bias cannot be realized until a resistance breakout. The falling wedge can also fit into the continuation category. As a continuation pattern, the falling wedge will still slope down, but the slope will be against the prevailing uptrend. As a reversal pattern, the falling wedge slopes down and with the prevailing trend. Regardless of the type (reversal or continuation), falling wedges are regarded as bullish patterns.

Below is an example of the falling wedge pattern in stock Rowan.

James Fournier 17/12/2011

1. 2. 3. 4. 5. 6.

Prior Trend: To qualify as a reversal pattern, there must be a prior trend to reverse. Ideally, the falling wedge will form after an extended downtrend and mark the final low. The pattern usually forms over a 3-6 month period and the preceding downtrend should be at least 3 months old. Upper Resistance Line: It takes at least two reaction highs to form the upper resistance line, ideally three. Each reaction high should be lower than the previous highs. Lower Support Line: At least two reaction lows are required to form the lower support line. Each reaction low should be lower than the previous lows. Contraction: The upper resistance line and lower support line converge to form a cone as the pattern matures. The reaction lows still penetrate the previous lows, but this penetration becomes shallower. Shallower lows indicate a decrease in selling pressure and create a lower support line with less negative slope than the upper resistance line. Resistance Break: Bullish confirmation of the pattern does not come until the resistance line is broken in convincing fashion. It is sometimes prudent to wait for a break above the previous reaction high for further confirmation. Once resistance is broken, there can sometimes be a correction to test the newfound support level. Volume: While volume is not particularly important on rising wedges, it is an essential ingredient to confirm a falling wedge breakout. Without an expansion of volume, the breakout will lack conviction and be vulnerable to failure.

As with rising wedges, the falling wedge can be one of the most difficult chart patterns to accurately recognize and trade. When lower highs and lower lows form, as in a falling wedge, a security remains in a downtrend. The falling wedge is designed to spot a decrease in downside momentum and alert technicians to a potential trend reversal. Even though selling pressure may be diminishing, demand does not win out until resistance is broken. As with most patterns, it is important to wait for a breakout and combine other aspects of technical analysis to confirm signals. Given the nature of this trade, investors will be able to use a tight stop-loss to limit risk whilst allowing the trade to run - maximizing upside potential.