Both Gold and Crude Reverse Sharply as Risk Appetite Stalls, ECB Disappoints

Despite a reported tumble in fuel consumption in the US and an improvement in growth forecasts from the IMF, both crude and gold would extend their impressive rallies to new relative highs. Where do fundamentals end and speculative begin?

North American Commodity Update

Commodities - Energy

A Lack of Volume Finally Catches up to Oil's Rally, Commodity Suffers Biggest Drop in 5 Week

Crude Oil (LS Nymex) - $ 81.40 // - $ 1.83 // -2.20 %

Over the past two weeks, crude has climbed through tepid risk appetite trends, questionable fundamentals and (more importantly) fading speculative inflows. Having rallied over 10 percent in just the past six days, the market finally found itself overextended and running short of fresh capital. And, as the bid dried up, those traders that were late adopters on the upswing would move in quickly to cover and in turn spark a sharp reversal in oil itself. Just a day after confirming a break above August's swing high to a fresh five-month low, crude put in for its sharpest decline since August 31 st . What traders need to ask themselves now is whether this correction is a merely a temporary pullback meant to shake out the unfaithful or the beginning of a true reversal. That likely has more to do more with speculative objectives than anything else.

With today's disappointing performance from oil, there are a few fundamental events that could be referred to as catalysts. The Bank of England and European Central Bank's decisions to keep their stimulus regimes as is was certainly a disappointment for a capital market that is lacking for true fundamental and capital milestones to latch on to. To develop a sense of optimism in economic expansion in both the US and globally, government and central bank-supplied stimulus is one of the few factors that can reasonably be expected to fuel expansion. At this point, only the Bank of Japan has officially taken a policy of stimulus expansion. The Federal Reserve has only put a floor under its existing $2 trillion program; and now, both the BoE and ECB have deferred expansion of their own. In the meantime, supply-and-demand relevant economic indicators released today offered a modest subsidy. German industrial production for August grew 1.7 percent (more than three times the forecast) while UK-based manufacturing activity grew at its fastest annual rate (6.0 percent) since December of 1994. Stateside (oil's tumble did start around the open of the US markets), initial jobless claims hit a three-month low. If we wanted to benchmark our expectations to a particular indicator though, the real threat is tomorrow's US employment report. This can alter growth forecast, risk appetite and the outlook for the Fed's stimulus effort - an all encompassing indicator.

Data aside, however, it is important to note that the promise of economic activity is not the primary source of strength for oil (indeed a slowing in economic activity heading into the close of the year should clue us into that). Instead, the expectation for stimulus and the risk appetite that is derived from that anticipation keeps oil rising on lighter volume. We note that in today's plunge, we would see a record volume in the November Nymex futures contract (416,414 turnover) compared to reserved turnover during the preceding rally. Conviction (the emotional term to a capital inflow) is imperative to sustaining a genuine trend.

Crude Futures Chart ( Daily )

Chart generated using FXCM Strategy Trader

Commodities - Metals

A Surge from Gold and Silver Earn an Equally Aggressive Reversal

Spot Gold - $1, 333.55 // - $ 15.50 // -1.15 %

Already pitched in a remarkable bullish trend for two months, gold's amplified rally through Tuesday and Wednesday opened the market to a speculative correction. With such an aggressive advance, the probability that a wave of speculative interest joined the more stable investment capital flow was high. And, traders that are looking only for capital gains from a market that is already trading at a record high when it was struck by a surge in volatility know that the advance has a short half-life. We saw the limits of this conviction come Thursday when the commodity dropped from a record high with its biggest daily decline since July 27 th . Giving us some perspective of the speculative involvement in this move, we note that the intraday peak to trough in the session's decline was a remarkable 2.85 percent. We haven't seen a drop of this magnitude since the opening day of June.

For a catalyst, we can simplify our analysis by saying the dollar's stability through the day set against the extended rally of the previous 48 hours was reason enough for a correction. However, to truly dig to the heart of the matter, we can specifically identify a fundamental catalyst in the collective neutral stance of the ECB and BoE monetary policy meetings. A critical foundation to the metal's rally these past weeks is the concern evidence that the world's governments and central banks are attempting to expand stimulus to suppress (essentially the return on fiat currency) and intervene in exchange rates in an effort to boost competition. The net effect for global capital is that this undermines the confidence in stability and return possible in traditional currencies and the assets they are used to price. Naturally, investors will seek out an alternative for their wealth as long as this manipulation is being exercised. With the European central banks' decisions to refrain from boosting stimulus, there is some evidence that capital cannot flow into this already expensive commodity forever. And, for an always speculative group, it could even be suggested that the Fed may not actually boost its own efforts. That is dangerous thinking that can lead to a crash in risk appetite and gold while the dollar would find the spark of a rally. In the medium-term, the precious metal and gold will stand on opposite sides of the coin.

Going back to the overextended argument for today's price action; we should note that up until today, futures volume was weak despite the underlying asset's steady advance. However, with today's reversal, we have seen signs of life. From the active December Comex futures contract, we had a record surge in volume (246,203). What's more, total ETF holdings of the precious metal saw their biggest daily drop since July 28 th . From a more speculative angle, the SPDR Gold Trust reported its biggest jump in volume since May 6 th (38.657 million ounces).

Spot Silver - $ 22.51 // - $ 0.67 // -2.89 %

With risk appetite trends (measured through the S&P 500 and other standard benchmarks) otherwise silent and gold tipped into its biggest drop in weeks, it is only natural that silver would put in for a correction of its own. Following a virtually uninterrupted 32.5 percent climb this past six weeks, the metal put in for its biggest single day decline since July 27 th . For additional color, it is also noteworthy that the intraday peak to trough decline would measure 4.3 percent. As for turnover, futures volume nearly doubled on the December contract from 47,916 to 82,896 contracts traded.

Spot Gold Chart ( Daily )

Chart generated using FXCM Strategy Trader

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Written by John Kicklighter , Strategist

To receive John's reports via email or to submit Questions or Comments abo ut an article; email jkicklighter @ dailyfx .com

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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