Head of Commodity Strategy
Summary: A relatively quiet week in commodities with the different sectors trying to weigh the impact of several key developments such as the weaker dollar, rising equities, trade talks as well as Brexit developments.
It has been a relatively quiet week in commodities with the different sectors trying to weigh the impact of several key developments such as the weaker dollar, rising equities, trade talks as well as Brexit developments. The IMF downgraded global growth to the lowest level since the global financial crisis while China, the world’s biggest consumer of raw materials, saw its Q3 GDP slow to 6%, the weakest since the early 1990’s.
A combination of a weak demand at home and lower exports due to the ongoing trade war with the U.S. has taken its toll on Chinese growth, although recent economic data point to signs of green shoots beginning to emerge.
The USD weakness was spearheaded by GBP and EUR strength. The potential for a Brexit deal helped drive Sterling to a five-month high while the euro, the favourite short among speculators, reached a seven-week high.
The potential for a mini-trade deal between the U.S. and China, which could be signed in November at the APEC summit in Chile, helped support those agriculture commodities that may receive a boost from increased Chinese demand.
In addition to the prospect for increased demand from China, key crop prices in the U.S. are now also being supported by the impact of the delayed planting season leading to a delayed harvest. The yet to be harvested crops of soybeans and corn may increasingly be left vulnerable to extreme cold and rain. Something that ultimately could lead to a price supportive reduction in output.
Crude oil traded lower but overall it looks as if both WTI and Brent crude oil continue to settle into relative tight ranges around $55/b and $60/b respectively. The global outlook for demand remains challenging with the current weak sentiment not being helped by a recent IMF global growth downgrade and uncertainty surrounding trade negotiations between the U.S. and China. Opec and Russia may, given the current demand outlook, be forced to maintain and potentially cut production even further in 2020. Whether that can be achieved or not is likely to refrain the market, barring any renewed geopolitical event, from rallying anytime soon.
President Putin’s visit to the Middle East region this past week further cemented the increased cooperation between Russia, Saudi Arabia and its allied in the GCC. A development which began in earnest back in early 2017 with the agreement to curb oil production in order to stabilize the price. Russia is also likely to seize the opportunity left open by Donald Trump’s increasingly erratic behaviour when it comes to foreign policy decisions.
Perhaps reducing the need for Opec+ action is the fact that US shale production growth has slowed in 2019 and look set to slow even more over the coming years. Lower crude oil prices and increased scrutiny from investors looking for a return instead of rapid growth have led to an almost continued reduction in the weekly rig count since last November. The XLE ETF which tracks the performance of U.S. crude oil and natural gas producers has underperformed the S&P500 by close to 20% so far this year. An indication of lower investor confidence and one that may hamper future growth through lack of investments.
However back to the current weak sentiment which is being reflected by the attitude towards oil from large speculators. According to weekly data from the U.S. CFTC, hedge funds dumped 87,000 lots (87 million barrels) of WTI and Brent crude oil futures during the week to October 8. The combined net-long dropped to a nine-month low of just 301,000 as the risk premium following the September attacks in Saudi Arabia was removed.
Worst hit was WTI where the long position dropped to their lowest level since 2013. U.S. sanctions against China's COSCO Shipping Energy Transportation Co. prompted a recent spike in the cost of chartering Very Large Crude Carriers (VLCC). Before eventually easing this week, the cost of transporting crude oil from the US Gulf coast to refineries in the far east is likely to have triggered a slowdown in exports and, with that, rising inventories.
Gold has now spent more than two months trading sideways around $1500/oz. From a chart perspective the lower highs point to fading momentum. The same formation however could also signal the emergence of a bull-flag which, if broken above $1510/oz, could see it resume its rally. A deeper correction to $1450/oz or even $1415/oz would do little to remove the long-term bullish view many, including us, currently hold on gold. Only a break below $1380/oz, the old range top and 61.8% retracement of the June to September rally could change this view.
Gone for now is the roaring bond engine which back in June and July helped the yellow metal break above $1380/oz and with that outside of its multi-year range. But despite seeing bond yields stabilize following their rapid descent, U.S. stocks near record high and the outline of a trade deal emerging, gold has nevertheless managed to avoid a major correction.
This indicates that it remains in demand, not only from short-term speculative players – who otherwise would have tried to send the market lower to squeeze out longs - but also from real money investors looking for diversification amid a slowing global growth outlook and various geo-political risks.
The below charts show some of the current drivers impacting the price of gold along with silver and to a lesser extent platinum. The recent rise in real yields and reduction in global negative yielding debt from 17 to the current but still formidable 13.4 trillion dollars have both helped reduce but not remove the appetite for investment metals.
Total holdings in bullion-backed, exchange-traded funds have seen a relentless rise since May and they are currently just 26 tons below the December 2012 record. Hedge funds maintain a near record net-long through futures and it is the potential reduction from this category of traders that currently poses the biggest challenge.
In the short-term, while the market transitions from focusing on lower yields, which may have run its course for now, the precious metal market could be left vulnerable. However, following a period of consolidation, we see gold move higher to reach $1550/oz by year end before moving higher into 2020. Some of the supportive drivers that could take over from falling bond yields are likely to be a weaker dollar, continued central bank buying and FOMC rate cut focus.
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