Commodities: Oil gains on cold snap – grains held back by bearish USDA report

Oil gains on cold snap – grains held back by bearish USDA report 
The past week has seen mixed developments in the commodities complex: oil has seen
continued support from a cold snap across the northern hemisphere, while wheat prices
are down a little in Europe after a relatively bearish US grains report.

More broadly, a range of weather phenomena has been driving commodity prices higher
of late: cold weather across the northern hemisphere is driving up prices of oil and a range
of agricultural products (wheat, corn, sugar, orange juice). Notably, Australia is currently
experiencing a drought in the West and flooding in the East. In addition, Europe has seen
snow early in the season and a cold snap is affecting the US - both reducing the outlook
for grains for the coming season and adding to demand for heating oil.

OPEC maintains quotas as IEA raises demand forecasts 
Last Friday, the International Energy Agency (IEA) raised its global oil demand forecasts
for 2010 and 2011 to 87.4 mb/d and 88.8 mb/d, respectively. OECD forward demand
cover rose however, to now stand at 60.1 days. IEA highlights in its Medium-Term
Outlook that 'call on OPEC' is due to rise significantly out to 2015. Meanwhile, OPEC
said in its monthly report ahead of the gathering in Quito that world oil demand is
expected to come in at a mere 87.1 mb/d next year.

As widely expected, OPEC kept production quota unchanged at 24.8 mb/d at the cartel's
meeting in Ecuador on Saturday. Saudi Arabia reiterated the country's call for oil prices to
trade between USD70-80/bbl. With prices at present trading just above the USD90 mark,
there is thus some room for members to continue to keep producing despite the current
low levels of compliance. Interestingly, secretary general al-Badri said that "if prices go
high because of speculation we can do nothing about it". Alongside comments that oil
demand and supply are currently in balance, he thus hinted that USD90+ is a 'blip'
potentially caused by investor flows.

Notwithstanding, we think that OPEC will gradually move its target range for oil prices
higher as 2011 sees stock draws. In our view, OPEC is currently aiming at USD80-90,
but it may let the range edge higher to USD90-100 in H2 next year.

The weekly DOE report showed that US crude stocks saw a significant dive last week.
However, the sharp drop was largely caused by a decline in imports as refiners may have
cut down on inventories to save inventory taxes over the new year.

Risk of aggressive Chinese tightening is rising 
Chinese activity and inflation data released over the weekend showed that the economy is
expanding and that inflationary pressures are mounting. According to our Asia economist,
China's monetary policy is still too accommodative and we expect the pace of monetary
tightening to increase next year. The targets for credit growth will probably be reduced
and the possibility of more explicit quantitative controls on credit cannot be ruled out. In
addition, we expect four interest rate hikes over the next year.

We still think a rate hike before year-end is likely, although the PBoC's decision not to
hike on Friday could indicate some reluctance to increase rates. We expect faster
appreciation of CNY next year to be part of the Chinese policy response. On the whole,
the risk that China has to tighten policy aggressively next year in order to curb inflation is
rising. This could spur a sell-off in risky assets and hence certainly poses a risk to our
bullish commodities call for 2011.