A number of physical commodities have managed impressive recovery moves in the first half of 2009, and in most cases those gains were justified by improved demand expectations. However, some markets saw the early seeds of inflation-based buying, and that might have temporarily pushed them into an overbought condition. In fact, the COT positioning reports pegged the net spec position in the gold market to be long 222,215 contracts as of May 26th, and after that report August gold prices managed an additional rally of almost $40 per ounce. The crude oil market showed a net spec long positioning of 117,389 contracts and then managed to add another $6.50 per barrel before that market topped out. In addition to crude oil and gold, copper, silver, unleaded, cocoa, the Canadian Dollar, Pound, Euro and the stock market also caught a ride off the recovery angle. Therefore seeing a number of those markets correct last week wasn’t surprising, as the trade was justified in fearing residual damage to the economy in the employment sector. However, markets like copper, sugar, coffee, cotton and natural gas still look to have bullish potential in the coming quarters, even if some of them might face some near term corrective action. Markets like crude oil, gasoline and soybeans might have priced in fairly upbeat demand expectations, so it could take real proof of an economic recovery to prompt them to resume their recent uptrends. Markets like gold and silver seem to already be looking beyond mere recovery action to the prospects of inflation.
Certainly, unprecedented borrowing by the US government to head off the crisis and the historical easing efforts by a large number of central banks leaves the prospect of inflation on the table. Germany’s Chancellor Merkel recently called for global central bankers to “return to reason” in their to monetary policies, and that seems to give the prospect of inflation some credibility! However, it has long been our opinion that in order to return to inflationary conditions, the economy would have to be entrenched in a recovery mode, and as of the first week of June, that recovery was hardly assured. We would suggest that the recovery action in most commodity markets over the past five months is indeed an early warning sign of what might be in store in the event that the world economy actually gets back on its feet. Robust physical commodity buying by China and a surprising 5.4% growth rate from India suggests that areas outside of the US are capable of getting back to some semblance of normality more quickly than the US.
For those who maintain that high oil prices are the result of speculative fervor or that ultra high oil prices were some form of contrived condition, seeing oil prices quickly return to the vicinity of $70 per barrel has to be a very troubling development. While energy prices are likely overvalued for the near term, we look for them continue to move in sync with global equity prices. Prior to the sub-prime crisis, high energy prices were the feedstock of inflation. We expect to see energy prices contributing to “reflation” in the second half of 2009.
The financial crisis appears to have passed, but the economic slowing threat has yet to be reversed. Therefore, traders need to be long markets with favorable fundamentals, but they also need to protect those positions with options for the coming weeks and perhaps months.
