Nifty , Sensex , Stocks, Commodities , Forex: Weekly Fundamental Outlook

Eventually, we saw some retreats in the energy and base metal complexes as driven by declines in stock markets. Since March, market sentiment has turned very positive as improvement in some economic indicators signaled that the pace of economic contraction has slowed down. S&P 500 Index has risen 29% after hitting the lowest level in a decade. Crude oil price also picked up with the rally accelerate in April.

Long-awaited pullbacks were seen last week as industry data revealed the fact that we are still undergoing a recession, the deepest one after WWII. Moreover, economic outlook forecast by both the ECB and BOE provided were more dovish than previously anticipated, though both of them agreed the degree of deterioration should be less severe than in the past 2 quarters.

Crude Oil

Crude oil price's decline accelerated in US session Friday as driven by correction in stock markets. The June futures lost 3.8% to settle at 56.34 yesterday. There were a series of economic data released in the US. Though largely inline with market expectation, the data indicated the nation's economy is still weak. CPI contracted -0.7% yoy in April, compared with market expectation of -0.6% and -0.4% in the previous month. On monthly basis, the reading stayed flat. Industrial production dropped for the 6th consecutive, by -0.5% in April while March's reading was revised down to -1.7%. Empire manufacturing Index and the Michigan confidence surveys, on the other hand improved much more than anticipated. The Dow Jones Industrial Average slid 0.75% to 8268.64 and S&P 500 Index plunged 1.14% to 882.88.

Earlier last week, oil price rallied to 6-month high at 60.08 as a report by API showed a huge withdrawal (-3.3 mmb) in crude inventory for the week ended May 8. This surprised the market as consensus forecast was a 1 mmb gain and investors interpreted the decline as a sign of improved oil demand. However, a series of demand downgrades by major forecasting entities presented the hard facts that outlook remains bleak for the rest of the year. The benchmark contract slid 3.9% for the week.

All of the US Energy Department, OPEC and the IEA revised down their forecasts on oil demand in 2009 based on their lower estimates on global economic forecasts. The US Energy Department's now anticipates oil demand to drop 1.8M bpd in 2009 from a year ago, representing a 0.4M bpd reduction from previous projection. The IEA reduced another 0.2M bpd and currently expects global oil demand to contract 2.9M bpd to 83.2M bpd in 2009 from 2008 while OPEC cut its demand forecast by a 0.2M bpd and now sees oil demand falling 1.6M bpd to 84.03M bpd in 2009. These estimates showed that we are not out of woods yet and the biggest recession after WWII will continue to deteriorate the oil market for the rest of the year.

Added to investors' disappointment was the seemingly bullish oil inventory data by the US Energy Department. Although crude inventory decline 4.63 mmb last week, it was driven by sharp fall in imports, rather than increase in demand.

Weak demand, plentiful inventories and low utilization indicated the vulnerable oil fundamentals. In the coming weeks, we expect oil price to extend correction so as to reflect the fragile market situation.

Earlier last week, we mentioned that correlation between stock market and oil price has increased significantly over the past few months (ONG Focus: Oil Price Pulls Back In Tandem With Stock Markets. Correlation Between The 2 Surged Significantly). In fact, recent rally in oil was driven by robust market sentiment and advance in stock markets, rather than sector-specific fundamentals. Will the situation change in the coming week? Will oil market's movement derail from equity markets?

As mentioned just now, we expect further weakness to oil price. At the same time, we are also awaiting correction in stock markets. While it's true that some data showed that the worst of the economic downturn has been behind us, there's still a long way to go for recovery. US leading indicators roughly trough half a year before the economy hits bottom. Therefore, even if we see a strong rebound in leading indicators next week, the economy may not get out of recession until 6 months later. However, rises in stock markets and some commodities over the past few weeks seem to have priced in strong growth ahead! We believe the rallies were overdone.

Natural Gas

NYMEX Natural gas plunged 4.5% to settle at 4.098 Friday as the US recorded another month of contraction in US industrial production and below-zero reading in manufacturing survey in April. Despite a surge to as high as 4.575 Wednesday, pullback in stock markets and decline in crude oil price dragged down gas price which ended the week almost 5% lower.

Since last April, US gas price have soared more than 40% as the sharp decline in gas rig counts since September 2008 boosted concerns on supply tightening. Moreover, signs of bottoming of recent economic slowdown boosted expectation of better demand in the future. During the past few weeks, we observed significant capitals flowing into natural gas ETFs which helped pushing price higher. A report from Barclays Capital stated that, in April, natural gas ETF has inflows coming in at $0.5B, with AUM (asset under management) at $1.1B, the second highest for that ETF on record. The report also said some of the capitals have switched from oil in to gas ETFs.

The overextended rally made us even more worried about outlook on natural gas as current price level may prolong the demand/supply imbalance. As high gas price stays longer, coal-gas substitution may halt as gas price is getting more expensive. Gain in US gas price also narrows its gap with UK gas price. This will motivate LNG imports to the US, thus increasing supply. Moreover, import from Canada may rise should the price difference between US and Canadian gas reduce or US gas price trades at a premium to Canadian gas. This will also increase gas supply in the US.

Precious Metals

Gold price traded steadily with upside bias last week. Settling at 931.3 after surging to 6-week high of 934.8 Friday, the yellow metal added 1.8% for week with rise in inflation expectation the main driver.

The chart below shows how inflation expectation affected movement in gold price over the past 10 years. The spread between 10-year and 2-year US Government bond yield acts as a proxy for inflation expectation (the wider the spread, the higher expectation on inflation). From 1995 to the first half of 2005, gold price tracked inflation expectation quite well, indicating the former as a good inflation hedge. Although gold price's trend derailed from that of the yield curve from the second half of 2005 to 2007, it was probably because the extremely weak USD and growing interest in commodity investments stimulated rally in gold price. We do not think this should affect the high correlation between gold price and inflation expectation.

Look at the yield spread recently, it has almost reached the cyclical high of the series and indicated investors have priced in high inflation in the future. However, gold price has clearly underperformed as it's still trading at low range as displayed in the chart. We believe the phenomenon is due to range-bound trading in USD.

While we remain bullish on gold price in the long-term, near-term price movement will not be smooth as long as the USD refuses to decline sharply. Our ideal situation for gold is that market concern about quantitative easing policies in the US re-emerges and this causes downturns in equity markets and the dollar.

Silver price edged slightly higher by 0.4% last week to close at 14.01. Since the start of the month, COMEX futures for silver has surged 14% while gold rose of 4.5%. Since the beginning of 2009, silver has attracted investors'/speculators' interest as a cheap proxy for gold. Over the last 2 weeks, we saw significant pick up in speculative net long positions in silver after weak numbers in April.

Base Metals

LME Copper (3-month delivery) plummeted 5% to close at 4450 last week. Although China's strong copper imports and fixed asset investments in April helped support the price, worse-than-expected industrial production in the world's 3rd largest economy, together with weakness in stock markets triggered profit-taking. Cancelled warrants dropped sharply to levels last seen in early April, indicating contraction in demand from China.

In the base metal complex, aluminum price has lagged behind while lead and copper prices have gained the most. Year-to-date, LME aluminum price for 3-month delivery gained 0.9% while both lead and copper soared 46%. Zinc, tin and nickel also rose 27%, 25% and 7% respectively. The weakness in aluminum price was driven by its sky high inventory which rose to a record high of 3.9M metric tons this week. Apart from robust domestic production, continuous surge in imports in China has created huge surplus in that country and it's negative for price.