Head of Commodity Strategy
The Bloomberg Commodity Index has seen its year-to-date gains disappear following four weeks of heavy selling. The broad-based index, which tracks 22 major commodities evenly split between energy, metals and agriculture, has been hurt by a stronger dollar and trade war angst as well as expectations that Opec+ will increase production in order to cap crude oil’s upside.
The current robustness of the US economy compared with the rest of the world has led to the current divergence in monetary policy between the Federal Reserve and other major central banks around the world. As a result, the global economy, especially emerging market economies carrying a heavy debt load, has seen a more challenging environment as the dollar strengthens and liquidity becomes tighter.
Adding to this, the current risk of trade protectionism means questions are being raised about the impact on growth and subsequent demand going forward. This is potentially one of the biggest challenges commodities will face over the coming months.
Industrial metals have been caught at the center of these concerns, not least following a tough couple of weeks for China where weakness in key economic data and trade concerns helped send the Chinese CSI 300 index down to a one-year low. Zinc was hardest hit as it slumped to a ten-month low while HG copper once again looked for support at the bottom of the range it has stayed within for the past nine months.
Gold and silver spent the week trying to consolidate following the latest slump which took gold below key support thereby attracting additional technical selling.
Agriculture commodities were led lower by the crops potentially being negatively impacted by trade wars. Not least cotton and especially soybeans which at one point dropped by more than 18% from the May peak.
Opec crude oil meetings the centre of attention
Most of the attention once again was directed towards the energy sector as the market waited for the outcome of Opec and Opec+ meetings in Vienna. Faced with rising pressure from emerging market economies feeling the economic impact of rising fuel costs, a stronger dollar, and higher (dollar) funding costs, the Saudis felt the need to adjust production instead of risking slowing demand growth.
Once again, however, the decision had become a political hot potato. Not least after President Trump in recent tweets singled out Opec as being the culprit behind surging oil prices. Iran’s oil minister instead put the blame squarely on the US given the current sanctions on Venezuela, and soon Iran as well.
Given the political influence of US sanctions these two countries initially showed strong opposition, but in the end the cartel managed to find a compromise because of the need to maintain stable prices and a desire to ensure sufficient supplies to keep the upside capped.
By keeping the production ceiling from December 2016 in place the group instead opted to raise production in order to bring its compliance back to 100% in order to offset the near 1 million barrels/day. The group is currently producing below its stated target. The move initiated by Saudi Arabia was probably also seen as way to pre-empt any market worries about an even bigger shortfall once US sanctions against Iran officially begins this November.
In the short term we are likely to see crude oil being supported by continued geopolitical risks related to supply concerns from Venezuela, and not least Iran, as the deadline for the implementation of US sanctions approaches. These concerns may, however, eventually be replaced by a shifting focus towards a continued rise in non-Opec supply and demand growth which may begin to suffer due to a slowdown among emerging market economies.
Saudi Arabia and Russia seem to have drawn a line at $80/b as being the level above where they fear that demand destruction could emerge. On that basis we maintain the view that Brent crude oil over the coming months will remain range-bound between $71 and the low $80s before downside price pressure begins to emerge ahead of the year end and into 2019.
Gold’s negative correlation to the stronger dollar has provided the main directional source during the past couple of months as seen below using EURUSD. But the dollar showed signs this past week of pausing after EURUSD failed to break below €1.15 while the Dollar Index ran out of buyers above 95. However, until precious metals pick up other themes such as inflation, trade wars and rising recession risks the dollar’s behaviour will hold a major sway over the market, in both directions.
Gold not shining so brightly any more
Our positive outlook for gold has been challenged following its rapid descent this past week from $1,300/oz to $1,260/oz. Despite having seen the technical outlook deteriorate, thereby attracting fresh short selling, our view on gold and silver remains constructive. This, given the raised risk of an economic slowdown combined with rising inflation hitting the market. Having picked a strong fight on trade with friends and foes it is also our belief that President Trump will sooner or later go on the attack against the stronger dollar as greenback strength complicates his vision of reducing the US trade deficit.
For silver, the technical outlook, as mentioned, remains challenged, with the metal so far managing to bounce ahead of $16.10/oz which is the trend-line support going back to the January 2015 low. Gold, meanwhile, needs a break back above $1,286 before altering the technical outlook.