High risk aversion in commodity spectrum

In a week marked by disrupted correlations and extreme volatility, precious metals were caught up in near indiscriminate selling across the commodity spectrum rather than suffering from any commodity-specific bearishness.

In November, commodities and other asset classes had been hit by the resurgence of risk aversion amidst concerns over European sovereign debt and rising interest rates in China. Nevertheless, prices in most sectors are holding up strongly with the bulk of October’s gains still intact.

The Fed’s largely anticipated decision to inject further liquidity into the markets to boost growth certainly helped to cheer up investors. In fact, the Fed’s decision was so anticipated and discounted in the run-up to the decision than when the act itself was consummated, the big move up in all asset prices caught everyone by surprise.

Also, funds making huge returns in commodities as an asset class this year will be looking at crystallising the profits ahead of the financial year-end and as we go closer to that, any rally will be met with broad profit-taking.

Precious metals: Gold and silver have been the strongest performers over the past nine months. However, the majority of this outperformance has occurred since September, which we believe has been in response to US efforts to stimulate growth via a further round of quantitative easing. In fact, a stronger American real economy data have led to an increase in GDP growth forecasts recently. This is expected to sustain downward pressure on the gold to silver ratio. At a time when the gold price is likely to be moving above $1,600 an ounce suggests silver prices heading towards $40 per ounce is achievable in the medium to long-term. Technically, we could see gold prices correcting to $1,300 and silver near $24-25 owing to risk aversion.

Base metals: We expect conditions to weaken for the industrial metals complex over the balance of this year and into the first quarter of 2011. We believe this will be driven by monetary tightening in China and ongoing European sovereign risk fears. Of the five broad commodity sectors, Industrial metals have displayed the most sensitivity to a slowdown in Chinese loan growth.

We believe the introduction of investor capital through ETFs could have important repercussions for industrial metals and provide additional support specifically for zinc and nickel into the latter half of next year. The key driver will be increased demand for galvanised steel in consumer products such as automobiles and appliances.

Technically, we anticipate copper to possibly test $7,500 per ton on LME and metals like Zinc and Nickel holding firm at present levels with a possibility of a minor correction which can be used to position longs.

The author is director, Commtrendz Research