Commodity Outlook – 2011.06.06

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The outlook for commodities as of the beginning of June is somewhat suspect, as the world is concerned about slowing growth in the US and China and many economists are disappointed with the lack of rebuilding signals from the Japanese economy. But as strange as it may sound, it is possible that the evidence of slowing from inside and outside of the US over the last month might hold a silver lining for some commodity markets, as enough slowing could give credibility to the talk of extending QE2 or even implementing some form of QE3. As the September US Treasury Bond chart indicates, the fear of slowing is being widely embraced in the interest rate markets, and that has tempered the bid for several physical commodities. The ongoing burden on the US economy from negative reverberations in the US housing sector probably has the Administration and certain members of the Fed on edge again, especially if the recovery becomes even more suspect in the weeks ahead.

However, talk that high energy prices are crimping consumer spending should begin to moderate slightly, as nearby RBOB prices were recently as much as 32 cents a gallon below the April highs. But while the bullish buzz from the energy complex might be temporarily under wraps, US heating oil and gasoline stocks are at relatively tight levels (see chart) and US refinery operating rate recently showed that almost 17% of US refineries were idled. The spring demand lull is over now, and that means tightening product stocks will likely remain a threat throughout the coming US summer driving season. With the US government recently warning against price gouging, we also think that some US refinery operations will be idled more quickly in the face of slumping margins or almost any sign of weakness in demand, as most companies don’t want to risk being attacked by the Justice Department for charging more, especially if they are facing thinner profit margins.

Even the grain markets started the month of June on a slight corrective track, as a break in the pattern of unrelenting rain events throughout the US Midwest allowed planting progress to play some catch-up. That probably served to shift the focus away from delayed planting progress and toward weather conditions going forward. In addition to the potential for reduced US yields because of the later plantings, the market is also seeing a threat against European feed wheat production due to drought, as well as from dryness in China. While US weather conditions could become more conducive to planting, it should not be forgotten that as of May 29th Ohio still had almost 3 million corn acres unplanted. In North Dakota, only 55% of the spring wheat crop was planted as of May 29th, a record low for that date. The 10-year average is 90%. With initial forecasts for June calling for an entrenched hot and dry pattern, the grain trade is concerned that the weather is poised to go from one extreme to another. This could be detrimental to the crop if the pattern lasts more than two weeks. Still, one also has to wonder if a large contingent of fund longs will be content to stick with their long corn positions in the face of a favorable weather pattern and in the face of slack to weak expectations for the economy in general.

In the face of global slowing evidence and noted price recovery efforts in sugar and cocoa during May, traders might look to attack the short side of both of those markets. Facing a period of rising supply and potentially suspect demand ahead, it wouldn’t be surprising to see them fall down to their lowest levels since the 4th quarter of 2010.

The commodity markets need to see an improvement in scheduled data flows, a fresh downside breakout in the Dollar, or a significant threat to physical oil supplies to fully reignite the commodity bull market. In the meantime, we suggest that traders wait for a return to the May lows, in some cases to the 2011 lows, before entering back into the long side of the market. Aggressive traders might actually look to sell cocoa, sugar, crude oil and natural gas, as those markets appear to be poised for a correction.