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WCU: Commodities rise ahead of crucial week

Commodities 8 minutes to read
Picture of Ole Hansen
Ole Hansen

Head of Commodity Strategy

Summary:  Global markets, led by emerging market bonds and stocks, advanced alongside US stocks where a robust earning season has so far helped offset the negative impacts of a prolonged government shutdown and global growth worries.

Given what is on the plate next week one can argue that we are now moving from the starter to the main course in terms important market moving events. Among the most important we find:

  UK Parliament vote on Brexit ‘Plan B’
  Deadline for Huawei CFO Extradition Notice
  US FOMC Meeting
  US-China Trade talks in Washington
  Further developments in Venezuela

So far, January has presented a very friendly investor environment with global markets continuing to recover from the December onslaught despite continued worries about an economic slowdown hitting major economies. The International Monetary Fund has lowered its global economic forecasts for 2019 and 2020 in response to risks including trade tensions and rising interest rates. However, the reduction in global growth from 3.7% to 3.5% was viewed as optimistic given the impact of a prolonged US government shutdown together with a weaker outlook for Europe and not least China, which last year saw the slowest rate of expansion in almost 30 years. 
Commodities, still heading for their best monthly performance since April 2016, have recorded strong gains so far this months in both energy and industrial metals. These two sectors have both managed to rally despite the current focus on slowing growth and with that, the risk of a slowdown in demand. 

This highlights the importance of not only focusing on macroeconomic prospects but also looking out for tightening fundamentals. The Opec+ agreement to cut oil production has supported the sentiment change in energy. Industrial metals have found support from the progress being made on the trade front while pockets of looming shortages and rising demand have helped offset the almost daily dose of headline risks.
Bloomberg commodity index
Soft commodities are mixed with cocoa continuing its month-long decline on abundant supplies in West Africa, the world’s top-producing region led by the Ivory Coast. Sugar has been benefiting from the stronger Brazilian real and the prospect of increased demand for cane towards ethanol production as crude oil recovers.

A lack of US data due to the US shutdown has left the grain sector increasingly rangebound and struggling for direction. Wheat is being held up on speculation of a slowdown in Russian exports as domestic prices rise. Soybeans traders, meanwhile, are focusing on the prospect of a trade deal while also being supported by concerns about the size of Brazil’s crop following a recent dry spell. 

WTI crude oil remains stuck in a $50 to $55/barrel range with ongoing production cuts from the Opec+ group of nations being offset by global growth worries. So far, the Energy Information Administration, the International Energy Agency and Opec have all kept their 2019 outlooks for global demand growth stable. 

Downward revisions, however, are now likely to surface following the aforementioned downgrade from the IMF and the OECD’s composite leading indicator, which in November dropped to 99.3 points, a six-year low and a level that has previously signalled recession

Venezuela’s deepening crisis supported prices during a week where US crude stocks rose the most since November and gasoline inventories climbed to a record. President Maduro’s dreadful regime, which has driven more than 2 million people out of the country while leaving the rest in poverty and misery, is finally seeing a strong challenge from Juan Guaido, the elected leader of the National Assembly. He has declared himself acting president under article 233 of the Constitution, which authorises him to become interim president in the event of “serious misconduct” on the part of the elected president. 

The prospect of a major disruption in Venezuela combined with the risk of the US government ordering a halt to imports from Venezuela helped narrow WTI’s discount to Brent crude. The prices of Mexican and Canadian oil, two alternatives to Venezuela’s heavy crude oil, both outperformed WTI crude oil. 

The outcome of this uprising could have a major short- and long-term impact on the global oil market. The deteriorating economic outlook and lack of foreign investments in Venezuela’s ageing oil industry have triggered a 50% collapse in production during the past few years. The country’s abundant heavy crude reserves are just what the world needs at a time where the US barrel is getting lighter and lighter due to rising shale production.
Venezuela oil output

The recovery since the December trough has so far been relatively shallow with the 38.2% retracement at $55.55/b yet to be challenged. Venezuelan uncertainty has added another dimension to an oil market already struggling to digest multiple moving parts. The price could rise should additional sanctions further reduce exports, not least to US refineries along the Gulf of Mexico geared towards handling heavy crude oil.

While awaiting further developments, the market is likely to remain rangebound within the highlighted $50/b to $55/b trading area. The level of speculative positioning in WTI crude oil remains clouded in uncertainty with the US CFTC not issuing any data since December 18 due to the government shutdown.

oil price chart
Source: Saxo Bank
Gold continues to hold its ground. Despite headwinds from surging stocks and higher bond yields, spot gold has now since December 28 managed to trade sideways within a relatively tight $1,277 to $1,300/oz range. Gold markets received an additional bid on Friday on speculation , first mentioned in the Wall Street Journal, that the Fed may be preparing to reduce the scale of its quantitative tightening programme. If true we have possible melt-up scenario in stocks while the dollar could weaken.

While data covering the speculative behaviour from hedge funds in the futures market remain unavailable, investors have continued to accumulate exposure to gold via bullion backed ETFs. Total holdings have reached 2,253 tons, the highest since 2013, in response to investors looking for protection against both macroeconomic and geopolitical uncertainties. Answers to some of these uncertainties may be found next week with trade talks, Brexit vote and the Federal Open Market Committee all potentially having a market moving impact.

While we will not rule out the short-term risk of a deeper correction, we maintain a constructive view on gold as highlighted in our Quarterly Outlook published earlier this week. Using the run up from $1,200/oz as a starting point, we will be looking for support at $1,260/oz followed by $1,247/oz.
gold price chart
Source: Saxo Bank

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