WCU: Crude oil and gold deflate on easing tensions

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector has had a mixed week with the energy sector witnessing a lot of selling while the agriculture sector was supported by short-covering and China increasing goodwill buying ahead of high-level trade talks next month


The commodity sector has had a mixed week with the energy sector witnessing a lot of selling while the agriculture sector was supported by short-covering and China increasing goodwill buying ahead of high-level trade talks next month. Acting as a drag on the whole commodity space has been the dollar, as the Bloomberg Dollar Spot Index of ten major currencies headed for its strongest weekly close since May 2017. 

Industrial metals - led by aluminum - traded lower with a combination of geopolitical, trade and economic risks weighing on the demand outlook, especially from China. Precious metals traded close to unchanged on the week. This following a roller-coaster week where another attempt to break higher failed as the dollar jumped. Silver was particularly volatile, as it added another 3.5% down day to the two already recorded this September.

Source: Bloomberg & Saxo Bank

US traded natural gas also fell and ended up being the biggest looser among the key commodities shown above. Record seasonal production is not being met by a similar rise in demand and this has resulted in storage caverns filling up at a rapid pace. The injection season, where production exceeds demand lasts until mid-November, at which point increased winter heating demand begins to reduce stock levels. 

Sugar reached a one-month high as a record short held by speculators began to get squeezed. The market is beginning to price in expectations for a 2019/20 global deficit after India’s output was downgraded due to flood damage.

Soybeans, which has been held hostage in the year-long US-China trade war received a half-hearted boost from news that China was stepping up its goodwill buying ahead of October’s trade talks. According to Customs data, China imported 1.68 million tons of U.S. soybeans in August, the highest level in four months. However, the past 12 months overall have seen imports decline by 68% compared to the previous 12 months. This may explain why President Trump wants the Chinese to buy a "tremendous" amount of soybeans as a first step towards reaching a trade deal.

Source: Saxo Bank

The crude oil pendulum swung violently the past few weeks, following the September 14 attack in Saudi Arabia on Abqaiq oil-processing facility, the world’s biggest, and the Khurais oilfield. With the immediate risk of retaliation and escalation fading after Saudi Arabia agreed to a partial ceasefire in Yemen, the $5/b risk premium that the market attached to the price in the days following the attack continued to deflate.

Saudi production has recovered much faster than expected and this combined with a counter seasonal rise in U.S. stocks, continued growth/demand worries, and a stronger dollar all helped drive crude oil lower for a second successive week.

We see enough risks to supply on the horizon to think that a sustained return to $60/b Brent and below is unlikely at this stage. A potential trade war escalation however could further damage the price as it would add pressure to an already weak growth outlook from China and India to Germany and the U.S.

Source: Saxo Bank

This past week gold and silver investors resoluteness was once again being tested after the yellow metal posted its biggest one-day drop in three weeks on Tuesday, while silver added another 3.5% down in the day, to the two already recorded this September. The four major parts continuing to impact the outlook with alternating force are: the dollar, bond yields, equities and geo-political developments.

Investor participation remains high: During the rally on Tuesday to $1535/oz total holdings in bullion-backed Exchange-traded funds jumped by 22.2 tons. It is currently less than 55 tons below the 2012 record of 2,572 tons. Also, on Tuesday, the number of total outstanding futures contracts on the gold contract traded in New York, the so-called Open Interest, reached a record 659,000 lots.

While expressing a firm belief in gold, these developments also raise concerns about a correction should the market fail to hold onto support, currently between $1500/oz and $1484/oz (chart below). From a technical perspective it is also worth keeping in mind that a move down to $1446/oz would be categorized as being a weak correction only within a strong uptrend.

While the current geopolitical developments in the Middle East have so far only had a limited impact on gold, it is instead the US – China trade talks and the dollar which hold the key to its outlook. The risk to global growth - which has supported the collapse in global bond yields - has led to renewed rate cuts from major central banks.

Source: Saxo Bank

We maintain a bullish outlook for gold with the combination of a prolonged period of low real yields and slowing growth prospects, made worse among EM countries by the strengthening dollar. Adding to this multiple geopolitical risk and a U.S. – China trade deal which remains far from being finalized. 

The short-term outlook may however turn challenging given the mentioned strengthen of the dollar. Gold's strong rally earlier this quarter occurred despite a stronger dollar. With the dollar index toying with the highest level since early 2017, gold would - if the rally continues - have to put up a strong fight to avoid being dragged down.

We view the dollar strength - which is the main theme in our Q4 Outlook to be published on October 3 - as temporary. However, given the size of recent established gold longs, we may witness a period of nervous trading in gold, silver and platinum. 

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