Weekly Fundamentals - Gold to Get More Appealing as Economic Outlook Deteriorates, SNB Intervenes
Sentiment deteriorated rapidly on Friday amid renewed fears the Greece may default although officials in the country reaffirmed that the progress of the debt roll over scheme 'is satisfactory' and things are advancing in a positive manner'. Economic outlook in the Eurozone as a whole remained worrisome. Top ECB official Juergen Stark resigned on Friday after the ECB delivered a dovish September statement a day ago. Stark, the most hawkish member in the ECB, criticized that the bong purchase program should be temporary. While his departure was due to 'personal reason', it unveiled the division among the committee. On Thursday, the ECB left the main refinancing rate unchanged at 1.5% and delivered a dovish accompanying statement. The central bank revised lower growth forecasts and did not signal upside risks to inflation. ECB staff forecast annual real GDP will grow 1.4-1.8% in 2011 and 0.4-2.2% in 2012. The projections were revised lower when compared with June's estimates. The risks to the economic outlook are tilted to the downside. Concerning inflation, policymakers believed near-term risks are 'broadly balanced'. While rises in commodity prices and increases in indirect taxes and administered prices might drive up prices, weaker than expected growth in the Eurozone and globally present some downside risks. Staff projections on inflation stayed unchanged at 2.5-2.7% for 2011 and 1.2- 2.2% for 2012. President Trichet said the committee 'never pre-committed' and stands ready to do 'whatever is necessary', the tone of the statement suggested that the ECB is ready for a rate cut should the economy deteriorate further.
US President Obama unveiled a 450B job proposal which mainly targeted tax cut and investments. While more details will be released on September 19, the measures include a tax-cut for small businesses if they hire new workers or raise workers'; a 4 000 tax credit if a company hires anyone who has spent more than 6 months looking for a job and extra tax credits if they hire America's veterans; a 1-year payroll tax cut; extension of unemployment insurance and assistance on refinancing homeowners' mortgages. The market largely ignored his announcement as the measures have already been priced in. We believe the next major event is the 2-day FOMC meeting to be held on September 22.
Crude Oil: Oil prices continued to track macroeconomic sentiment last week. Prices fell early in the week at the aftermath of disappointing non-farm payrolls in August. Losses were reversed in the middle of the week amid speculations that President Obama's job stimulus plan would help on growth. As we approached the end of last week, the dovish ECB statement, resignation of ECB executive member Stark and renewed concerns of Greek's debt problems dampened confidence and triggered a new round of selloff in risky assets including oil. Days of volatile trading resulted in only mild gains in both benchmark crude oil contracts.
The only predictable thing in the highly uncertain market is the widening trend of the WTI-Brent spread. The gap between the 2 benchmarks have widened to 26.87/bbl on September 6 although stock in Cushing, Oklahoma, the delivery point of the NYMEX crude futures contract, has been dropping steadily. The DOE/EIA also addressed the issue recently, forecasting that a large WTI discount to persist through the end of 2012. According the agency, the recent trend has not been brought about by Cushing stock which 'has been falling fast in the last few months' Rather, transportation bottlenecks in the Midwest and the stock situation in Brent's own regional market have been the key factors. The Brent crude futures market is in backwardation, suggesting tightness in the supply side. As we mentioned in previous articles, suspension of oil production in Libya during the 6-month civil war has raised supply concerns in European despite the release of oil from IEA strategic storage and pumps from Saudi Arabia. Although the National Transitional Council ( NTC ) is confident the Libya's oil production can reach 500-600K bpd within a few weeks, and can return to the pre-war level of 1.6M bpd within a year, the DOE/EIA maintained the forecast that only about 50% of oil production will be resumed by the end of 2012 while Wood Mackenzie said it will take around 36 months for the country to return to full production of 1.6M bpd. Shell's force majeure on Bonny light exports and sanctions on Syria only exacerbated the demand/supply balance.
The DOE/EIA believed that 'logistical bottlenecks' are the 'primary factor of the WTI disconnect'. 'Growing land-locked crude oil supplies in Cushing and limited refinery access to those supplies' are reasons that have keeping oil prices in the region low compared with other domestic and international benchmarks. Indeed, apart from the WTI-Brent spread, the gap between WTI and Louisiana Light Sweet (LLS) crude has exceeded 15/bbl this year. The price difference has provided a strong incentive for increasing petroleum movements out of the Midwest.
Despite recent decline in Cushing inventories, the capacity may 'soon be overwhelmed by renewed growth in exports from Canada or regional refinery maintenance. Pipeline companies are going ahead with plans to add capacity out of the region, whether through new, dedicated lines (Keystone XL, awaiting regulatory approval) or by reversing and/or expanding existing infrastructure, as Magellan and others have announced'. The WTI-Brent spread will likely persist and may even widen further, 'until such plans come closer to being realized, or the crude supply balance in Europe significantly improves'.
EIA expects that total natural gas consumption will grow by +1.8% to 67.3bcf/day in 2011 and then by +0.6% in 2012 to 67.7 bcf/day. For the week ended September 2, gas storage increased +64 bcf to 3025 bcf. Stocks were -131 bcf less than the same period last year and -60 bcf, -1.9%, below the 5-year average of 3085 bcf. Separately, Baker Hughes reported that the number of gas rigs fell -3 units to 892 in the week ended September 9. Oil rigs slipped -7 units to 1057 and miscellaneous rigs stayed unchanged at 9 units, sending the total number of rigs to 1958 units, down -10 units from the previous week. Directionally oriented combined oil, gas, and miscellaneous rigs decreased -3 units to 235, while horizontal dipped -2 units to 1134 and vertical dropped -5 units to 589.
Precious Metals: Gold fell on profit-taking after reaching a new record high of 1923.7 on September 6. Ending the week at 1859.5, the yellow metal remained at elevated price level and further correction cannot be ruled out. That said, we retain our view that gold will gain support on decline and will eventually set new record highs as long as global economic outlook remains uncertain. The SNB announced last week that it would no longer tolerate a EUR/CHF exchange rate below 1.20 and is prepared to purchase foreign exchange in 'unlimited quantities'. Even under the new target, the central bank said that Swiss franc is still high and should 'continue to weaken over time'. The SNB pledges to take further measures, if 'the economic outlook and deflationary risks demand it'. While the move had sent gold lower instantaneously, it should benefit the metal in the long-term as SNB's decision should enhance the safe-haven appeal of gold which is not subject to intervention.
The next event risk for gold's movement would be the FOMC meeting on September 22. Preside Barack Obama announced a job growth proposal worth of $447B after data showed that August payrolls stagnated. Given the dismal growth in the US employment market, FOMC members will have rigorous debates on whether to implement additional easing measures. We believe further easing is imminent as it may come as early as in September. Such a move by the Fed should drive gold higher.