US’ economic data and Bernanke’s speech boosted market confidence and reversed the commodity sector. With the exception of natural gas and nickel, price returns for commodities were positive last week. However, as current economic outlook remains weak and upcoming indicators have high chances of downside surprises, we are wary that the late-week rally may be short-lived.

Fed Chairman Ben Bernanke’s speech at Jackson Hole unveiled his view that the US economic should continue to expand in the second half of the year, albeit at a relatively modest pace. The Chairman also affirmed the market that the central bank has sufficient tools to stimulate the economy and combat deflation when there’s a need. With talks of 4 policy options including 1) additional purchases of longer-term securities, 2) modification of the Fed's communication language, 3) reduction in the interest paid on excess reserves and 4) increase in inflation goals. It appears likely that further QE measures will be implemented, albeit not in the near-term.

US GDP was revised to +1.6% q/q in 2Q10 from preliminary reading of +2.4%. Yet, the market took this as positive as the downward revision was less than previously anticipated. Elsewhere in the UK, GDP rose +1.2% q/q in 2Q10, compared with initial reading of +1.1%.

Crude Oil

Crude’s rebound accelerated in US session as US’ 2Q10 GDP came in stronger than expected and Fed Chairman Ben Bernanke saw continuation in economic growth. These fueled confidence that oil demand may evolve better then feared. The front-month WTI contract jumped to a 1-week high of 75.45 before settling at 75.17, up +2.47%, Friday. The contract also halted the 2-week decline with a gain of +2.33%.

Brent crude also rose, surging +3.22% from the prior week to settle at 76.65, as UK’s 2Q10 GDP was revised up to its performance in 9 years. Brent’s premium to WTI futures widened at a point to more than $2/bbl on Friday, the highest level since May.

Crude oil price started the week with a downward bias, slumping to an 11-week low of 70.76 on Wednesday after the US Energy Department’s report showing record high oil and petroleum inventories. Economic data from the US was very disappointing with durable goods orders, new home sales and existing home sales surprising to the downside.

Buying interests however emerged above 70, while corresponding level for DJIA is around 10 000, and investors used the reduction in the weekly initial jobless claims as the reason to enter long positions. In fact, we do not view the jobless claims data as a bullish one as the 4-week moving average indeed climbed higher.

In coming months, we expect oil price will to a large extent be driven by macroeconomic outlook, especially in the US. Although growth of oil demand mainly comes from emerging markets, such as China, India and the Middle East, in recent years, oil market in the US continues to be closely monitored. Therefore, macroeconomic outlook in the US should remain important for oil price movements. In the near- to medium-term, macroeconomic environment in the US is expected to stay weak and the dataflow has high probability to show further downside surprises. We therefore expect oil’s rebound over the past few days to be short-lived.

Natural Gas

Natural gas tumbled to an 11-th month Friday as deteriorating economic outlook will exacerbate the ample inventory situation. The September contract plunged for a 4th consecutive week and settled at 3.651, down -11.3%.

Gas storage increased +40 bcf to 3052 bcf in the week ended August 20. Stocks were -198 bcf less than the same period last year and +177 bcf, or +6.2%, above the 5-year average of 2 875 bcf.

The number of gas rigs dropped for a second week, by -12 units, to 973 units. Despite the dip, the number of gas rigs is high given the weak demand situation. In recent years, producers have been focusing on exploring horizontal rigs, a tool used to drill the most highly prolific unconventional wells. The situation can to result in rapid growth in gas production even though the rig count is falling.

Precious Metals

Heightened economic uncertainty and renewed worries over peripheral European economies extended gold’s rally for the 4th week. The benchmark Comex contract for the yellow metal rose to an 8-month high of 1246 before pulling back amid profit-taking. We remain positive for gold’s long-term outlook.

The chart below shows gold’s recent rally has been accompanied with slides in bond yields. With G7 bond yields tumbling to record low levels, talks about potential price bubble emerges. A report from Credit Agricole CIB suggests that the household sector may be creating a bubble as families are ‘running historically high debt holdings and banks, pension funds, insurance companies and many others must feel debt-heavy’. They have ‘resigned themselves to low levels of return and a fairly deflationary environment’.

This triggers worries about gold’s outlook given the synchronization between gold and bond prices. In our opinion, the likelihood of a bond market bubble in low although a correction in the near-term cannot be ruled out. Moreover, it’s not necessary for gold price to be affected even if the bond market collapses.

We do not share the view of a potential Treasury crash hinges on the risk-averse market sentiment and the Fed’s commitment to keep the monetary policy accommodative. At the annual symposium at Jackson Hole, the Fed Chairman Ben Bernanke pledged to 'do all that it' can to ensure the recovery. Although there may not be further QE measures announced in the near-term unless the market situation deteriorates significantly, the decision to keep the balance sheet stable by repurchasing MBS proceeds signaled the Fed opted for an ultra-easy monetary stance. With the Fed funds rate staying at exceptionally low level for a longer period of time, we should be comfortable with a lower short-term yield.

Even if there’s a bond market bubble, it will more likely happen in emerging bonds and corporate bonds. Collapses in these sectors usually happen in sovereign crisis and result in default, hence benefit gold.

Record gold price fails to deter buying in India and the National Spot Exchange forecast purchases may reach 600-625 metric tons in 2010, compared with 480-485 metric tons last year. In another report, the World Gold Council reported Indian imports reached 348 metric tons in 1Q10, compared with 559 metric tons in the full year of 2009.

Silver price also rallied and outperformed gold with a +5.83% gain last week. Platinum and palladium have followed the pattern of base metals but managed to rise +1.53% and +5.64% respectively during the week.

Base metals

Shrugging off the decline earlier in the week, the base metal complex underwent a strong rally on Thursday and Friday and sent the LME metal index higher, by +1.85%, to 3373.5. Industry data signals divergence in market balance the complex. The International Copper Study Group said the apparent refined copper market recorded production deficit of 190 000 metric tons (a seasonally adjusted surplus of 46,000 metric tons) in the first month of the year. This compares with a production surplus of around 8 000 metric tons (a seasonally adjusted surplus of about 223 000 metric tons) for the same period in 2009. There was a deficit as consumption outpaced production. Meanwhile, a report from the International Zinc and Lead Study Group shows that refined lead and zinc recorded surpluses of 50 000 metric tons and 176 000 metric tons, respectively in the first half of 2010. These readings indicate divergent supply/demand balances within the base metal complex. While the copper market may tighten further, other markets such as lead, zinc and aluminum may witness further increases in stockpiles.