Fundamentals

Oil Closes its Worst Monthly Decline Since December 2008 as Risk Appetite Retreats, the Dollar Rallies

North American Commodity Update

Commodities – Energy

Oil Closes its Worst Monthly Decline Since December 2008 as Risk Appetite Retreats, the Dollar Rallies

Crude Oil (LS NYMEX) -  $72.74  //  -$0.90 //  -1.22%

It is has been a bearish open to the year for crude. The commodity suffered its worst monthly decline since December of 2008 with a 12 percent tumble from the more than one-year high set earlier in the month. From a technical perspective, this swing has come upon its next make-or break level. In the past seven months, $72.50 has proven a difficult level to overcome and forge ahead with progress. Adding to its influence, this time around there the level happens to coincide with the general trend of lows that has defined the market’s advance since May of last year. Looking ahead to next week and month, direction may not be definitive but the potential for volatility is. There are major fundamental drivers behind the market that could quickly put crude back on its paces. Perhaps the most direct threat to the energy market’s health is risk appetite. In the past two weeks, speculative capital has reversed its flow in equities, commodities, currencies and carry positions. A speculative asset in its own right, oil is looking to the Dow and dollar for direction. The stock market offers a more objective bearing on risk appetite as investors buy when confidence rises and sell when the outlook for capital gains diminishes. The currency plays a duel role as both a funding currency and the primary pricing instrument for the commodity. The bearish bias on capital markets is in place; now we need a catalyst and momentum.

In the meantime, supply-and-demand factors will continue to develop in the background. The market initially responded as expected to the better-than-expected 4Q US GDP number this morning; but the growth reading would quickly lose its sway over price action after the data was absorbed. At face value, a 5.7 percent annualized pace of expansion and 2.0 percent growth in personal consumption both beat expectations. However, the former draws its comparison to the deep recession of a year ago and the consumer spending number is far from setting a pace for a boom period. Looking ahead to next week, the balance of supply and demand will be altered directly by manufacturing reports from the US, Euro Zone and UK among others. Moreover, though it may not have a direct link to fuel demand, the US non-farm payroll report will nevertheless exact a significant impact on oil price action.

Commodities – Metals

Gold Attempting to Hold back the Dollar’s Tide

Spot Gold  -  $1,079.90   //  -$7.22 //  -0.66%

While the markets were suffering from unfavorable risk trends, gold was able to hold back a critical break this week. Investor sentiment continued to flag, but momentum behind profit taking and position unwinding would notably temper its pace. This is not a sign that risk appetite will be suddenly revived next week; but it does offer bulls an opportunity to wrestle back some control over the markets. Evaluating the drivers of the past week, the US dollar will remain the primary fundamental catalyst for bearish gold bugs. While gold may have held on to support, EURUSD has forged fresh six-month lows and finds few prominent technical floors nearby. Should the dollar maintain its momentum, it is likely only a matter of time before this dollar-hedge follows suit. Along the same lines, the backdrop of risk appetite will be gauged for its influence on this speculative asset. However, should the retracement in risk appetite stall out around current levels, long-term investors and central banks who are looking to diversify away from currencies or volatile assets may treat gold as if it is trading at a discount and taking the opportunity to sop up large positions when liquidity is fluid. The commodity’s value as an inflation-hedge is another sleeper factor. Price pressures are already pushing dangerous levels in emerging markets and the developed market is just starting to feel the bite once again. When conditions return to the point that interest rate hikes are a global option, expect this fundamental driver to play a bigger role in price action.

Spot Silver  -  $16.14 //  -$0.11 //  -0.68%

Spot silver fell for the seventh day in eight to close out this week. Testing $16 per ounce support, the commodity is trading at near three-month lows and momentum is still in the bears’ corner. Risk aversion has stood as the primary driver over the past 24 hours just as surely as it has guided the metal over the past week. However, it is interesting to note that while silver has made bearish progress, the Dow Jones Industrial Average (our benchmark risk appetite) has more or less stabilized. This may denote a greater correlation to the US dollar rather than sentiment itself – a relationship that would hold up far more distinctly if risk trends would further align themselves to the bearings of the greenback.

Discuss gold and oil trading with other traders in the DailyFX Forum

Written by John Kicklighter, Strategist
Questions or Comments about this article? Send them to jkicklighter@dailyfx.com