The Overnight Report: Commodity Funds Panic

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By Greg Peel

The Dow finished up 61 points or 0.6% while the S&P added 0.8% to 1065 and the Nasdaq gained 0.6%.

Yesterday the ASX 200 surpassed its previous closing high of 4751 set on September 29 by closing at 4768. The close was also a tick above the previous 4767 intraday high but below the intraday high for the session of 4780. We are back in post-Lehman blue sky. The surge was all about the shock drop in unemployment, which stuck a cattle prod in an otherwise quiet morning market.

Last night the S&P 500 closed 6 points short of its previous high of 1071. At lunch time the broad index hit 1070 but some late profit-taking stemmed the enthusiasm. The Dow had been up 111 points at the same time. Last night’s session was all about positive influences.

It began with Alcoa. The first Dow stock to report in the season posted a strong result after the bell on Wednesday, thus setting the mood for Thursday’s trade. But then attention moved, once again, to the US dollar.

European Central Bank president Jean-Claude Trichet left the ECB cash rate unchanged last night at 1%, which was no great surprise, but suggested the European economy was stabilising and inflation was not seen as a threat. Currency traders responded, however, to what Trichet didn’t say. He didn’t say that the stronger euro (weaker US dollar) was hurting European export industries as the market had expected him to, which was taken as meaning the ECB would not act to temper the rise. He did state in a press conference that “a strong [US] dollar is extremely important in the given circumstances,” but such statements from central bankers seem increasingly hollow.

Meanwhile, the Bank of England also left its rate on hold at 0.5% as expected, and made no indication that quantitative easing was yet over. The end result was that the US dollar took a dive once more, finishing at 75.93 on its index to breach the support at 76 which has held the greenback for the past month or so.

The dollar’s drop was simply more fuel to the fire of the scramble to get long gold after the metal’s break-out into record territory. Gold was up another $14.30 to US$1056.40, having hit US$1060 before the US dollar index recovered slightly from a 75.80 low.

And there was also a scramble in London. Base metals had not, to date, shared in gold’s euphoria, only creeping up cautiously over the previous couple of days in response to what is merely a currency play. But many short positions had been established in metals in the belief they’d run too far, and particularly too far away from actual demand. But last night, all bets were off.

The drop in the dollar sent metal prices higher, aided by ongoing concern over a strike in Chile (copper) and rumours that a major Chinese zinc mine was to shut down. Daily inventories also showed slight falls across the board, which is unusual in recent times. The result was a sudden rush to cover short positions, Basemetals.com reports, as well as the setting off of stop-buy orders. (A “stop-buy” is the opposite of a “stop-loss”. A stop-loss is a sell order pre-placed to stem losses if a price falls to a certain level. A stop-buy is an order pre-placed to get into the market if a price rises to a certain level.) The stop-buy orders were placed by commodity funds which can’t afford to get trampled in the rush less their commodity weightings become unbalanced. Knowing this, the mometum trade speculators joined the party and metals surged towards previous 2009 highs.

Tin was up 3%, copper 4%, aluminium 5%, lead 6%, nickel 7% and zinc 8%. And it had nothing to do with industry demand. Yet it was enough to drive the materials sector in the US ever higher, and BHP Billiton ((BHP)) and Rio Tinto ((RIO)) shares were up another 3% in offshore trade as a result (note that they also had to catch up to Australian trade yesterday).

Oil didn’t want to miss out on the fun. It rose 3% or US$2.12 to US$71.69/bbl.

The news was also positive on the US data front. Last night saw the monthly collective reporting of same-store sales from major retailers, and some of the numbers blew analysts away to the upside. Discount stores lead the charge, and youth market stores once again put in recession-oblivious results. Importantly, higher level department stores saw their first turnaround in fortunes for many months, marking less-negative results. Nordstrom, as one example, showed sales down only 2% when analysts had expected a 6% drop. The share prices of many retailers surged around 5%, aided by fresh and more positive earnings guidance from several of the protagonists.

While the S&P 500 index did not make a new high last night, over 250 of its constituent stocks made new 52-week highs, which is a technically significant result.

Then there was good news on the jobs front. Economists had expected weekly jobless claims to post a fall last week of 11,000. But instead they fell 33,000, taking new jobless claim numbers back to January levels. Continuing claims fell to 6.02m.

Economists had expected wholesale inventories to fall by 1.0% in August, but they fell by 1.3%. Expectations were for wholesale sales to rise 0.7%, but they rose 1.0%. This marks the twelfth straight month of destocking, but increasing sales imply inventories are being cleared. The stock market bulls are putting great faith in the economic boost an eventual restocking will provide.

It was not all good news however. The US bond market has been confounding commentators of late by remaining well bid while risk assets surge and the US dollar tumbles. But at the end of another week of significant Treasury auctions, the thirty-year offering was not particularly well received. The yield on the thirties closed over 4%, while the ten-year yield jumped back 6bps to 3.24% in response. While traders argued that there was just too much buying ahead of the auction in aniticipation of a good price, foreign central bank participation was down to 34.5% from the 48.6% average of the last three auctions. Is foreign appetite waning?

The weak afternoon auction was enough to crimp the surge in the stock market and the collapse of the dollar. In the meantime, the Aussie dollar is up another 1.6 cents over 24 hours to US$0.9057, having breached the 90 level yesterday in response to unemployment number. With every cent the Aussie climbs, commodity export earnings fall.

After new highs were posted in the ASX 200 yesterday, the SPI Overnight was up 20 points or 0.4%.

It’s Friday. There are no major economic releases in Australia today and it’s been a solid week of gains.

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