WCU: Countdown to the 'G2' showdown

Commodities 10 minutes to read
Ole Hansen

Head of Commodity Strategy

Summary:  The upcoming G20 summit in Buenos Aires is essentially a two-man show as Presidents Trump and Xi decide whether the Sino-US trade war, currently weighing heavily on market sentiment, intensifies or moves toward resolution.

A holiday-shortened week due to US Thanksgiving proved another very challenging period for commodities. Continued weakness in crude oil and products, as well as agriculture, more than offset a small pickup in demand for precious metals. These developments helped drive the Bloomberg Commodity index towards its biggest weekly loss in five months and to the weakest close in 15 months. 

Global markets continue to worry about uncertainty related to the Sino-US trade war and its impact on global growth and demand together with a dramatic change in the short-term outlook for crude oil. 

The coming week will be a countdown to the showdown between President Trump and Chinese leader Xi Jinping who will be meeting at the G20 summit in Argentina from November 30 to December 1. The uncertainty triggered by an escalating trade war between the world’s two biggest economies is already being felt through the weakness in global stocks and more recently it has raised speculation about the Federal Reserve potentially slowing the pace of rate hikes into 2019. 

Both developments helped support gold which remains rangebound; the G20 outcome is likely to set the tone into the quiet December trading period ahead of Christmas and New year. 
Source: Bloomberg & Saxo Bank
Being hit in the pocket or being hit by Trump is the tough choice Opec will be facing when it meets in Vienna on December 6. Keep in mind that this is a meeting that just a few months ago looked like a mutual celebration of the cartel and its partners’ efforts to boost crude prices to an acceptable level.

Instead, the combination of rising production from the world’s three biggest producers, demand growth concerns into 2019, and not least Iran taking a smaller hit on its exports than was expected have turned the market upside down. Seven consecutive weeks of selling has seen WTI crude oil collapse from a four-year high to give back half of the gains achieved since hitting $26/barrel some 34 months ago.

Crude oil
Source: Saxo Bank
The current mismatch between rising supply and seasonal weak demand was further highlighted this week when Saudi Arabia said it had boosted production to record levels in excess of 10.7 million barrels/day. This combined with record Russian and US crude production, another weekly rise in US crude stocks, and President Trump applying continued pressure on Opec to keep up production was what help sent it even lower.

As the price continues to crumble, the expectations for a substantial production cut from Opec and others will go up. Reports have already been talking about a cut in the region of 1.5 million b/d. Adding to this, an expected pickup in global refinery demand over the coming weeks of a similar or even bigger magnitude should help eventually create a floor under the market. 

Before getting that far, the market will be left exposed to selling from banks protecting their producer hedges. Bloomberg reports that the premium that options traders pay for same delta puts over calls with a 12 months duration has reached the highest since the 2014 crash. On top of this, technical short-sellers have been encouraged by the negative momentum and Saudi Arabia’s weak hand against Trump following the murder of Jamal Khashoggi. 

While the G2 meeting between China and the US will attract most of the attention in Argentina next weekend, there is now also an increased focus on the potential for a G3 meeting between the world’s three largest producers represented by Trump, Russian president Vladimir Putin, and Crown Prince Mohammed bin Salman.  

Trump’s victory lap on Twitter this past week where he congratulated himself and Saudi Arabia for reducing the global tax on consumers is likely to have added to the unease already being felt in Riyadh. Saudi Arabia spent the past few months raising production to prevent a spike once US sanctions against Iran kicked in at the beginning of November. The fact that the Trump administration chose to grant waivers to eight countries, including two of the world’s biggest buyers, China and India, helped pull the rug from underneath the market. 

On a positive note, the collapse should reduce the risk to emerging market oil demand into 2019.  A country like India that could ill afford the near 70% year-on-year rise seen just a few weeks ago has seen the change drop close to zero as falling oil prices helped the rupee recover from a record low against the dollar.

In addition, the latest collapse is very likely to reduce forecasts for US crude oil production. Something that over time should help Opec and a make it easier to agree to a production cut. 
While other markets continue to suffer losses, gold remained relatively calm despite the headwind from continued dollar strength. We maintain a positive outlook for gold in the belief that a December rate hike from the Fed will only be followed by one more in 2019 before pausing. This development should see the dollar trade lower into 2019, much to the relief of EM economies troubled by the combination of rising dollar, rising debt, higher financing costs, and up until recently, rising oil prices. 

The G20 or more importantly the G2 meeting between Trump and Xi is likely to set the tone for the remainder of the year. A breakdown and subsequent escalation could see the Chinese renminbi weaken beyond seven to the dollar. Such a move would initially weaken gold before additional softness in stocks and lower bond yields could come to the rescue. For now, the yellow metal remains stuck in a $1,200/oz to $1,240/oz range with hedge funds holding an elevated short unlikely to worry unless the upper band of the range is broken.
Source: Saxo Bank
Silver suffered on Friday as the collapsing oil prices and low liquidity due to the absence of many US traders kept it under some relative pressure. It’s multi-decade discount to gold is only going to be reduced once the markets calm down and traders start looking for relative value. 

HG copper, meanwhile has, been trading sideways since July when the trade war helped send it sharply lower. We take is a sign of strength that it has managed to trade rangebound these past couple of months when global stocks have weakened on growth concerns, the trade war has increased, and crude oil has slumped by almost one-third. 

The saviour has been tightening fundamentals and the prospect of additional infrastructure spending, not only in China but potentially also in the US. Nickel, meanwhile, slipped to the lowest level since last December as rising evidence of an oversupplied market has left it vulnerable to the risks of a fading demand. 
Source: Saxo Bank
Please note that the weekly Commitments of Traders reports from the US CFTC has been delayed until Monday due to the Thanksgiving holiday. My next update covering speculators' positions in commodities will be published on Tuesday instead. 

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