Commodities Unwind: Will Sell-Off Continue Next Week?

Next week could prove to be another difficult one for commodity bulls. So far in 2011, we certainly have haven't seen the same upward momentum we saw in commodities in the last few months of last year. In fact, this downdraft in prices could continue for several session, if not several weeks.

Gold coins and bar
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Gold coins and bar

This week marked an important shift in sentiment in the commodities market that may linger into next week and beyond. Friday's disappointing U.S. non-farm payrolls number capped a week that saw a big unwinding of profitable positions in oil, copper, gold, and silver.

Job growth continues to be weak. Federal ReserveChairman Ben Bernanke indicated that it could take four or five years for the job market get back to normal. Therefore, there is no reason to believe that the Fed will reverse its stance on quantitative easing and efforts to stimulate the economy. Yet, commodities didn't rally on that assumption as they did throughout the last year.

In the final two months of last year, after the second round of QE was announced, oil and metals rallied nearly 10-20%. But since hitting new highs earlier this week, energy and metals have fallen sharply. This week, oil posted its biggest weekly decline since August. For gold, it was the steepest weekly drop since May.

The biggest driver in the sell-off has been market sentiment.

"It's a pivotal point. The market has to decide if it will be business as usual or a shift in the tide," says independent trader John Netto of M3 Capital. Technically, it appears there has been a severe shift.

"Gross exposures and sentiment are running frothy, but managers want and need to start the year off on the right foot," says Gregory Glatt, a managing director at Dominick and Dominick. "So they will buy dips rather than sell for the next few weeks."

Netto disagrees. He says many commodities traders are holding short positions going into the weekend and sees a continuation of the sell-off on Monday and Tuesday. " If traders don't step in here and buy the dips, the commodity unwind could gain velocity. If that happens, look for oil near $80, gold at $1320 and silver to fall toward $27."

Another major factor likely impacting commodities in the week ahead will be China's preliminary December trade data which comes out on Monday. Any signals that China may have to tighten credit could have an even greater negative impact on commodity prices.

Also important next week is the CFTC's hearing on Thursday on position limits and credit default swap moves, says RBC Capital Markets precious metals analyst George Gero, which could move liquidity in commodities markets offshore and further depress U.S. futures prices.