Why Fed's Move Got Ho-Hum Reaction from Commodity Markets
'Shock and awe' it wasn't. Though long awaited by global investors, the Federal Reserve's second round of quantitative easing generated a decidedly muted reaction in commodity markets. After the move, the Reuters/Jefferies CRB index of 19 major commodities settled flat at 305.07 late Wednesday.
Why the lack of excitement? Consensus expectations called for the Fed to announce asset purchases of $500 billion or more. What materialized was a commitment to buy an additional $600 billion in long-term Treasury bondsby the middle of next year. But this would work out to about $75 billion a month, which was a smaller monthly amount of new purchases than many analysts had expected. The U.S. central bank said it could adjust purchases depending on the strength of the recovery.
Commodity analysts said the move had largely been built into prices, which had run up sharply since August primarily under the influence of the weaker dollar as investors priced in more accommodation from the Fed. The CRB Index struck a two-year high of 304.98 on Tuesday and gold tells a similar story - the precious metal gaining nearly 4 percent last month and hitting a record $1,388.10 an ounce on Oct. 14.
"I feel the impact of the 'shot' was not powerful enough due to the drawn out process of the stimuli," said Jonathan Barratt, Managing Director of Commodity Broking Services in Sydney. "The market will probably take this as a sign that the Fed is endorsing their policy towards a weak U.S. dollar."
Spot gold had been a major beneficiary of dollar weakness as hopes grew for more quantitative easing. Prices fell as low as $1,323.64 an ounce on Wednesday after the Fed announcement but the metal recouped its losses towards the close.
"Our view is that the weakness in gold immediately following the Fed announcement was mostly profit taking as some traders pared long positions that they have accumulated in the lead up as they rode the rumors of more dramatic Fed action," said Ben Westmore, Economist - Australia & Commodities at National Australia Bank.
"In terms of dollar debasement, there is no doubt that the inverse relationship between gold prices and the dollar has once again asserted itself on this market," he said. "We think there could be some more dollar weakness to come, supporting dollar denominated gold prices in the next six months."
In the Asian session Thursday, the dollar remained close to a 28-year low hit against the higher-yielding Australian dollar after the Fed decision and not far off a 10-month trough against the euro at $1.4200, Reuters reported. The dollar index, a gauge of its performance against a basket of currencies, eased 0.1 percent to 76.31, just above its 2010 low set in October at 76.144.
NAB's Westmore added that the fundamental picture for gold remained strong. Robust investment demand, continued demand from central banks in the developing world combined with stronger jewelry demand in 2011 should "institute a floor under the gold price around the $1,200 level."
Lawrence Eagles, Global Head of Commodities Research at JP Morgan, said the bull market in gold "has been about preservation of value in the face of financial and inflation risks for the past two years."
Oil, meanwhile, "has largely been driven by the prospects for supply and demand," Eagles said. "At this point, I would still argue that it is the stronger growth potential for emerging market economies and a tightening physical market rather than future inflation risks that are driving oil prices."
Mike Sander at Sander Capital Advisors said although the Fed move "was baked into current prices with the Dow Jones only gaining modest ground," crude oil futures hit a fresh six-month high "indicating higher prices are going to occur."
"Oil traded well into the $85 range for the first time since May. The next barrier could come at $87 and if that is broken there is not much resistance beyond that. The Federal Reserve is basically devaluing the dollar even further, thus a rise in oil is not too surprising," Sander said. "At the same time it is saying the U.S. economy is in a very, very poor condition if the only way to get the motor going is to devalue the dollar further after many months of buying Treasuries and government stimulus."
John Licata, Chief Commodity Strategist at Blue Phoenix Inc., an independent energy and metals research company based in New York, argued the rally in crude oil was escalated by a larger-than-expected drawdown in U.S. refined product stockpiles reported by the Energy Information Administration. Distillate stocks, shrank by 3.6 million barrels last week and gasoline stocks fell by 2.7 million barrels, the EIA said.
Still, Licata expects the rally in crude oil will be "short-lived and I fully expect profit-taking heading into the holiday season as fund managers look to lock in hefty gains."
He added: "In my view, much of the thought process about inflation and a weak dollar is already being factored into the price of gold and oil. Both of my targets $1,375 and $87 per barrel have been seen this year so I do not expect much near-term upside in either commodity."
Some argue that U.S. policymakers seem to be tacitly endorsing a weaker dollar to help engineer an export-led recovery. The danger, however, is that a weaker dollar boosts raw material input costs for businesses and risks escalating currency tensions globally.
"I see the Fed's move as having a downward effect on the dollar and an inflationary effect on commodities in general," said Tom Weber, Managing Director at PFGBest,Commodity Futures & Options in Los Angeles. "I'll watch to see if this is the catalyst for competitive currency devaluation, and will trade accordingly."
Michael Langford, Senior Strategist at Stream Trading, says engineering a gradual decline in the U.S. dollar to boost export competitiveness is the current policy.
"Looking at Asian economies after the Asian financial crisis, it was export-led growth that got Indonesia, Thailand etc. out of the deep economic problems that their economies were facing," he said. "I think the U.S. is embarking on a similar strategy. The only issue is, other countries can see what the U.S. is doing and they do not like it."
The dollar as "the weak link of QE," says Dominic Schnider, global head of commodities at UBS. "Some regions could overheat and thereby favoring asset bubbles. In that sense, commodities are likely to trend higher over the coming quarters caused by a sliding USD. Commodity performance in other currency terms should therefore be considerably less."