Gold, silver look vulnerable in short-term

There are signals, albeit incipient, that the commodity markets may be stabilising after the volatile movements of recent weeks. Of course, there is little uniformity in price performance of various commodities. The oil market continues to face a period of volatility despite constructive fundamentals.

In particular, the entire metals complex has put up mixed performance. Some base metals have recovered, but the complex remains sensitive growth concerns, particularly fears of a Chinese slowdown. Precious metals have surely pared some value and are struggling to gain traction despite a fairly supportive environment.

The steel market is slowly turning sluggish with prospects of record production. April data suggest world steel production may reach an all-time record of 1,545 million tonnes. The market lacks direction. In China, steel prices edged lower last week amid mixed signals of stagnating market inventory and rising production. With the peak demand season now tapering off, mills have to rework their plans.

The big question currently engaging all participants in the commodities sector is how soon the Federal Reserve will review its easy money policy. The second instalment of Quantitative Easing (QE 2) is nearing an end. Humungous volumes of dollars bearing negligible interest have surely driven various markets in the last several quarters. The ECB last month started to tighten credit. Will the US follow suit and how soon?

Policy shifts will surely affect markets. Developing countries have resorted to ‘dear money' policy to beat inflation concerns. To be sure, major Asian economies such China and India, important players in the commodity space (energy, metals and agriculture) have been continually tightening their monetary policy. So, it is important to stay focused on such developments and be ready for unexpected outcomes.

Gold: The precious metal is struggling to gain traction despite reasonably supportive environment. Firming dollar and concerns over possible end to easy money flows have forced less-committed longs to resort to liquidation.

No wonder, on Friday, in London gold PM Fix was at $1,491 an ounce, down 0.2 per cent from the previous days. Not unexpectedly, silver was down 2.7 per cent on Friday with AM Fix at $34.80/oz. At the risk of repetition, it may be stated that the world silver market is in surplus in 2011 (approximately 3,500 tonnes). Prices cannot for long defy the fundamentals. Investor interest is the key; but such interest is known to be fickle.

On the other hand, World Gold Council has highlighted in its latest report that jewellery demand, particularly in India and China, has strengthened as also investment demand in coin and bar form. Physical demand is likely to provide a supportive floor for gold prices.

To what extent will the end of QE2 affect gold prices? Opinion differs. “It is generally believed that a very low interest environment is a key reason for investment in gold bullion given the low opportunity cost of investing in a non-yielding asset and the high tail risks associated with extraordinary monetary policy settings. Subsequently any change to this environment or suggestion that hint it will change in the foreseeable future will be important for gold”, commented an expert. If Fed changes its policy, we also need to look for possible changes in monetary policy elsewhere.

Despite weakness in the short-term, the possibility of gold moving higher towards $1,550/oz cannot be ruled out as supportive factors are still in place. Investor interest is, of course, the price driver.

However, technical analysts have a slightly different take. Gold faces risk if it breaks below 1460 towards 1410, while 1380 would provide excellent buying opportunity. As for silver, a break below 32 in silver would confirm near-term bearish view to targets near 29/30. Medium term view for both gold and silver is bullish.

Base metals: Prices have been mixed with some metals rebounding from recent lows after broad-based commodity sell-off and some stabilising; but there is no mistaking the fact that acute sensitivity to macro concerns remains in place. This is likely to lead to further short-term volatility.

Friday last, copper cash closed on LME at $9,050/tonne, up from the previous day's $8,927/tonne. Lead and zinc edged up, while tin was at $27,702/tonne from the previous day's $28,201/tonne.

Interestingly, the physical indicators for some metals are looking positive. In China, after de-stocking from the supply chain inventory, participants are drawing copper from warehouse stocks. The world market deficit of about 550,000 tonnes in 2011 cannot be wished away. So, price declines in copper provide excellent buying opportunity.

Crude: Despite recent correction, the fundamental backdrop for oil remains strong. The heightened volatility in the market is the result of strong demand, continued supply uncertainties on the one hand, and macro concerns and threat of slowdown on the other.

Supply side issues are far from resolved. The next OPEC meeting scheduled for June 8 would be watched with great interest. As of now, there is no indication of a supply response to prices.

According to technical analysts, a break below 95 in July WTI and 105 in Brent would confirm near-term bearish view towards 88 and 96 respectively. The medium term outlook is bullish.