(Kitco News) - Commodity markets as a whole received a few bearish pieces of news lately: China and the European Central Bank raising interest rates, Goldman Sachs telling clients to sell a few commodities, a potential cooling off of China’s economy.

That has led to a bit of a stair-step trade for several of the markets and this activity might be more commonplace as they look for direction in the near-term. The next event on the horizon for commodities is what might occur with the Federal Reserve’s second quantitative easing program, which is slated to wrap in up June. Further details on their plan could come as soon as the next Federal Open Market Committee meeting at the end of April.

There’s a fair amount of debate on whether the Fed will end the program as scheduled, or embark on a third round of quantitative easing. Quantitative easing occurs when short-term interest rates are as low as possible so the Fed buys longer-dated debt instruments to lower those rates. If short-term and long-term rates are the same, the yield curve is considered “flat.”

There are arguments on both sides about what the Fed might do. Ken Morrison, editor and founder of online newsletter Morrison on the Markets, thinks the bond-buyback program is coming to an end, at least for now.

“Politically it’s very hard to justify,” Morrison said, citing the debate in Washington about cutting spending. “It’s difficult to overtly continue easy liquidity.”

He said the interest rate hikes by China and ECB, and higher interest rate moves by other countries, are part of a global cycle which is reducing liquidity. The ultra-low interest rate environment has been the reason why assets of all kinds have seen their prices rise.

Ending the second round of quantitative easing could pressure prices across the board, much as ending the first quantitative easing program did last spring. “There’s a strong correlation between the Fed’s balance sheet and the S&Ps. Look at from April to August – the Fed’s balance sheet contracted by 12% - not that they were selling any assets, it was just debt maturing and rolling off. At that time S&Ps were off by 14%,” he said.

Because many financial and commodity markets declined last summer and worries about a potential “double-dip” raged, Fed President Bernanke said in August the Fed was considering a second quantitative easing program, which was put in place in October.

Since that comment in August, asset prices rallied to current levels.

The danger in the market, Morrison said, is that many commodity markets have seen speculators load up on long futures positions, so if the Fed wrapped up the quantitative easing program, speculators who were buyers could turn sellers. Unwinding these positions will take time which could lend consistent price weakness.

Morrison said futures markets like corn and crude oil have seen significant increases in net-long futures positions since last June, with crude oil at or near a record net-long. As of June 30, 2010, the net-long futures positions held by professional money managers was 10,000 contracts for corn and 37,000 for crude oil, Morrison calculated, based on the Commodity Futures Trading Commission’s commitment of traders report. The current net-long for corn is 415,000 and for crude oil it is 252,000.

In metals, the market that most reflects this growth is copper, which saw a net-long of 5,208 contracts in June 2010 versus a current net-long of 20,190 contracts. Gold and silver current net-longs are fairly similar to June 2010.

Earlier this week investment bank Goldman Sachs said it recommended selling certain commodities and taking profits. Those markets included copper and crude oil. Since the call came out early in the week, any initial selling related to Goldman’s recommendation will be seen in CFTC weekly data, which is set for release Friday afternoon.


The argument to extend or create a third quantitative easing program comes from market watchers who note that U.S. unemployment remains stubbornly high. They also said the Fed is not concerned about rising inflation, despite rising food and fuel prices, so there’s no need to end the program.

“The Fed came out before the Libya situation and said if there are any disruptions to oil we will continue the QE…. I think it’s reasonable to wonder whether we’ll see QE3,” said Ralph Preston, senior financial analyst at Heritage West Financial.

“I think what could put a lid on the market in the short-term is that Obama is presenting his plans for the deficit – and there’s across the board spending cuttings and higher taxes on the wealth. But that’s just for the moment. It’s not putting the brakes on this rally,” Preston said.

Mike Daly, gold and silver specialist at PFGBest, agreed the trend of interest rates in other countries and some concerns about a top in the markets are all valid points. But he said with unrest in the Middle East-North African regions and a still shaky global economy, he remains bullish on gold and silver. 

“Yes, QE2 ends in June, but maybe the question is, will there be QE3? No one knows,” Daly said, citing high unemployment as one example for continued liquidity injections.

Preston said until the Fed actively starts to raise interest rates a change in the trend won’t occur, especially for gold.

Daly said while there might be market pullbacks for one reason or another, that doesn’t change the big picture interest in commodities. “People want tangible assets. There is still too much geopolitical tension. In the long-term, the economy is not fixed,” he said.



By Debbie Carlson of Kitco News dcarlson@kitco.com

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