We entered 2010 with hopes of an economic recovery and while we received news over the summer that the recession "officially ended" in June 2009, we are still in recession mode as the Federal Reserve is adding stimulus rather than exiting accommodative policy.
Looking at last December’s market piece (see "Hot markets 2010: Hold on loosely"), it seems many of our analysts had a good grasp on the markets, at least until some surprises were thrown into the mix.
Knowing where we have been can help gain an understanding of where we are going. Overall, the three main themes that set much of the course for 2010 were the U.S. dollar, European sovereign debt concerns and harsh weather conditions.
Darin Newsom, senior analyst at Telvent DTN, says the U.S. dollar was a driver of the markets as it entered the year depressed, spiked and now is testing those lows. "A lot of those moves were a result of the Fed. That played a key role in commodities," Newsom says.
The dollar had a strong first quarter, excelling as the Fed finished the first round of quantitative easing in March and received a boost in the second quarter as the European sovereign debt crisis was coming to a head and investors sought the greenback as a safe haven. But with that crisis averted and hints of another round of quantitative easing (QE2) coming from the Fed, the dollar freefell, boosting commodities and commodity currencies.
The European sovereign debt crisis also played a significant role as the PIIGS (Portugal, Italy, Ireland, Greece and Spain) faced up to debt concerns that left many questioning their ability to operate without defaulting. The euro fell, leaving more than a few in the blogosphere warning of the end of the common currency. That sentiment turned pretty quickly as the Europeans put in place the European Stabilization Fund, which limited concerns over the viability of the euro according to Brian Dolan, chief currency strategist at Gain Capital.
Currencies defined many of the moves over the last year. "If you look at 2010, the overall trend has been currency evaluations. You can call it currency war, currency competition or whatever, but everything has been based off the U.S. dollar. As the U.S. dollar made its path to the downside clear, things in general made their way up," said Robert Chesler, account executive at FC Stone.
Finally, inclement weather shaped the outlook for a number of the commodity markets. News that the drought in Eastern Europe forced the Russians to ban exports of grains occurred as we were beginning to realize in the United States that there were issues with what had been expected to be a record crop. The U.S. Department of Agriculture (USDA) decreased projected U.S. corn yield from 165 bushels per acres earlier in the year to 158 bushels per acre in October, and flooding in Pakistan decimated the country’s cotton crop and made the country a net importer rather than exporter.
While our experts see opportunities in the metals, softs and energies sectors in 2011, they will all be significantly affected by what happens with the dollar.
Through the second half of 2010, gold and silver have taken a nearly uninterrupted trip to the up side with gold making nearly daily new record highs for a two-week stretch (see "Off to the races," below). Remembering the overarching themes for the year, those moves are easy to understand.
"The European crisis is how we got to that June [gold] record. That brought with it a beginning to spread distrust of paper currencies. Gold tried to correct after the European crisis was averted, but then the Fed started leaking hints at QE2 and people said, ‘let’s sell everything we can out of the dollar,’" said Jon Nadler, senior analyst for Kitco Metals.
Looking forward, how the dollar reacts to QE2 may be the canary for gold and silver. "If the dollar turns around and starts going higher for the next 60 days, gold could start back. In 2011, if the dollar falls apart again, then gold could certainly find itself again. Once it moves down first, it could have another very impressive year," Newsom says.
Nadler agrees, adding, "[If the dollar stabilizes in 2011], gold could come back to $850 to $1,150. We could start to see some better demand from the primary fabricators for jewelry and an abatement of the scrap coming to market."
Instead of gold or silver, which will be dependent on the U.S. dollar, Phil Streible, senior analyst at Lind Waldock, suggests investors look to China to determine the standout metals for 2011. "Chinese demand for copper is up as well as Chinese auto sales, which will affect the platinum and palladium markets," he says.
Nadler agrees that platinum and palladium may be standouts as "these are the ones with good fundamentals and have demand with actual users who don’t have the luxury of substitution." Look to the upside after they have established a floor of probably around $1,550 for platinum and $530 for palladium, he says.
Finally, Newsom says copper may be a leading indicator for the global economy. "If [the global economy] improves, the first signs will be seen in copper. It is going to close out 2010 stronger than [the other metals] and that is going to give it momentum going into 2011," he says. Streible projects copper may hit $4.20 per lb. on those fundamentals.