Head of Commodity Strategy
Summary: The negative economic impact of the coronavirus continues to escalate with the energy sector being at the epicenter of the market stress. A massive and growing supply surplus needs urgent attention from key players in order to avoid a total collapse in crude oil. Gold held its own despite multiple challenges while the agriculture sector emerged as the best performing.
Writing about global market developments at this moment in our shared history has been particularly challenging over the past couple of weeks. Denmark, like many other countries, is currently in a partial lock down while we watch the number of casualties from Covid-19 continue to grow, not least in Europe, the current epicenter, but probably soon in the US as well.
Working from home, trying to stay out of harms way, has been the right decision to adopt by governments. The flipside is the terrible cost in terms of lost revenues and pressure on smaller companies to stay afloat and to keep their staff on the payroll. Over the coming weeks and months we are going to see a dramatic jump in unemployment thereby signaling a temporary end to the good times that many have experienced during the past decade.
Governments and central banks have already stepped up and dozens of major bazookas have been fired in order to support individuals and companies. Perhaps we reached peak panic this past week, only time will tell. At least we’re seeing some stabilization emerging, not least from the stock market. For now, however, the strong dollar due to exceptionally strong demand and a broken bond market especially on the corporate side, highlights the challenging road that lies ahead.
Turning to commodities, the table below shows the damage inflicted on the sector so far this year. Crude oil, which is the glue that keeps the global economy going while also providing the main income for many countries and regions, has led the collapse. An extraordinary slump in global demand has opened up a 5 to 10 million barrels/day gap between demand and supply.
The price war started by Saudi Arabia two weeks ago combined with a continued drop in demand as countries grind to a halt and planes are grounded could see this gap potentially rise by another 5 million barrels/day from April and onwards.
The result of these developments has been an unprecedented oil price collapse which on Wednesday saw Brent crude oil touch $25/b for the first time since 2003. Compared with the average price of $65/b in 2019, the net reduction in payments from consumers to producers is currently close to $3.5 billion dollars per day.
Energy companies have suffered steep declines in their market cap during this time. With no letup in the price war, the attention has turned to the ability of heavily indebted production companies to survive this race to the bottom, especially in the US where binge borrowing and dismal returns on equity has left many smaller producers in trouble. It will become a race to the bottom unless drastic measures to curb supply are being implemented. The daily rise in storage could see tanks hitting peak capacity within months and such a development would eventually force production down. This however would be at a tremendous cost and pain to all, including Russia and Saudi Arabia.
What could change this race to the bottom would be the announcement of a production cut from the Texas Railroad Commission which regulates oil and gas production production in Texas, the world’s third largest production area. They have the authority to step in and order a reduction, just like they did in 1973. Such a move would dramtically increase the chance of dialogue and for Russia and Saudi Arabia to step back from the their war of words and war on price.
For the sake of the global economy and the wellbeing of everyone, both producers and consumers, the main focus over the next 12 months is to avoid reaching the top of the tank as the price would otherwise collapse. A production cut across the board of 10% would ensure that the oil market avoid this scenario. These are extraordinary times that requires extraordinary decision.
Gold’s failure to rally over the past few weeks, as Covid-19 spread and economic uncertainty rose, has triggered a great deal of uncertainty about what role it plays. In the short-term, the metal is being challenged by a continued demand to raise cash, a surging dollar and rising real yields as inflation expectations take a tumble.
We maintain a positive outlook and draw some parallels with what happened during and after the global financial crisis in 2008 and 2009.
Back then the eventual recovery started in gold mining stocks before moving to gold and it took another few months before the stock market finally bottomed out. With this in mind, we are keeping a close eye on gold mining stocks, through the Vaneck Major Gold Miners ETF (Ticker: GDX:arcx).
Gold has now been through a 15% top to bottom sell-off before once again finding support at $1450/oz. The correction has obviously once again raised the question of whether gold is worth it’s tag as a safe-haven and diversifier. We believe the long term reasons for holding gold has if anything been strengthened by current developments.
What about silver is a question many have asked after it collapsed to $11.65/oz, an 11-year low. The combination of being a lower liquidity metal, just like platinum and palladium, has borne the brunt of the cash-for-dash action this past week. The emerging recession added a further downside dimension given its 50% use in industrial applications. The gold-silver ratio meanwhile ballooned to a record 127 - ounces of silver to one ounce of gold.
Together with the Norwegian kroner they are at the confluence of the drivers that have been shaking global markets in recent weeks. Going forward, the price movements in these two very different markets should give an indication of the risk sentiment in the market.
The agriculture sector has now overtaken precious metals as the best performing commodity sector since the virus outbreak. This past week we have seen strong gains in Arabica coffee due to emerging supply-chain disruptions. Wheat has been another strong performer in response to surging demand from panicked consumers filling up their pantries with bread, pasta and cookies. This developments as well as signs of rising demand from China has strengthened four demand from mills with many turning to home baking.
Finally, over the coming weeks and months the focus is likely to remain squarely on the price damaging impact of the dramatic drop in demand for many key commodities from crude oil and industrial metals to some agriculture commodities. But as the coronavirus continues to spread it is very possible that the supply outlook will become challenging as miners and producers begin to feel the impact of staff shortages and the breakdown in supply chains. The impact of lower fuel prices is being felt from agriculture to mining as it drives down the input costs. However, the potential risks to supply could see some markets find support sooner than the demand outlook suggests.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
