Are commodities capitulating?

Posted on 04. Oct, 2011 by Riskelia in Weekly Focus | Comments Off

The main event of the last two weeks is undoubtedly the shift of commodities trends into negative territory. The precious metals fell sharply two weeks ago whereas the grains tumbled last week. This broad base correction is closely related to the deterioration of the Chinese growth outlook as perceived in the Shanghai equities’ poor performance and the rise in the Chinese CDS presently around 200 bps at levels comparable to the Lehman crisis.

The deterioration in Riskelia’s recommendation is showed in figure 1. The oil sector is the only bastion to resist but the trends of previous leaders, such as the brent and the heating oil, progressively surrender to negative territory. Interestingly, the correction of commodities has been more clearly anticipated on the commodities producers as showed in figure 2 which depicts Riskelia’s recommendations on the oil producers, materials and gold miners. The gold miners’ trend has sharply receded over the last two weeks providing a clear-cut signal on the battered commodities producers.

The unknown of the commodities outlook is still the behavior of the Commodities Index Traders, investors who gain exposures to commodities through ETC and structured products benchmarked on the GSCI or the Dow Jones UBS. As showed in figure 3, the index flows have started to recede but have still much room to fall in a pattern similar to the 2008 episode. The table (figure 4) of indices performance sheds light on the performance erosion due to the commodities futures rolling process. Whereas the spot return has been satisfactory over the last 5 years, the total return has been disappointing to say the least. Should the commodities complex fall more sharply (as they are only down around 10% in 2011), the passive investors still lured by the promise of commodities passive indices, could capitulate as they did in 2008.

Meanwhile, the oil complex curve, still in clear backwardation, still points to bullish fundamentals (figure 5). The tight supply / demand environment is focused on Brent and refined products. The loss of the Libyan oil, a high-grade, easy-to-refine crude oil obviously weighs on the refiners ability to transform highly sulfured oil into diesel. The tight diesel environment associated to the Brent scarcity is the last fortress to hold in the commodities complex.

Figure 1: Riskelia’s recommendations dynamic on commodities sector

Figure 2: Riskelia’s recommendations on commodities producers

Figure 3: Commodities Index Traders Cumulative Net Flows. Riskelia’s estimates in Billions USD.

Figure 4: Commodities Index Total Return and Spot Performance

Figure 5: Commodities’ curve signals. The Z score represents the deviation of the curve to a moving average (measured in numbers of standard deviations). It reflects the curve evolution, hence gives insight on the inventories dynamics.

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