Head of Commodity Strategy
Summary: Crude oil, in a downtrend since June, is showing signs of selling fatigue with the technical outlook turning more price friendly while fresh fundamental developments are adding some support as well. The energy crisis in Europe continues to strengthen, most recently due to lower water levels on the river Rhine preventing the movement of barges carrying coal and fuel products such as diesel. The result being an increased gas-to-fuel switching supporting the demand outlook for crude oil.
Crude oil, in a downtrend since June, is showing signs of selling fatigue with the technical outlook turning more price friendly while fresh fundamental developments are adding some support as well. Worries about an economic slowdown driving by China’s troubled handling of Covid outbreaks, and its property sector problems as well as rapidly rising interest rates, were the main drivers behind the selling seen across commodities in recent months.
Crude oil with its strong underlying fundamentals, with tight supply driven by Russia sanctions and OPEC struggling to lift production, was the last shoe to drop and since the mid-June peak, speculators and macroeconomic focused funds have been net sellers of both WTI and Brent crude oil futures.
With most of these market participants using the front of the futures curve, the selling has seen the forward curve flatten, a development that is normally viewed as price negative as it signals reduced tightness in the market. However, for that to ring true we should see inventory levels of crude oil and fuel products rise while refinery margins should ease. None of these developments have occurred and it strengthens our belief that the weakness sign has more to do with position adjustments and short positions being implemented by traders focusing on macro instead of micro.
In the week to August 9, the combined net long in Brent and WTI slumped to 304k lots a level last seen in April 2020, and 209k lots below the mid-June peak.
While the macro-economic outlook is still challenged, recent developments within the oil market, so-called micro developments, have raised the risk of a rebound. The energy crisis in Europe continues to strengthen, most recently due to lower water levels on the river Rhine preventing the movement of barges carrying coal and fuel products such as diesel. The result being surging gas prices as utilities are forced to buy more gas to keep the turbines running.
This week the cost of Dutch TTF benchmark gas reached $400 per barrel of crude oil equivalent. Such a wide gap between oil and gas has and will continue to attract increased demand for fuel-based product at the expense of gas and this switch was specifically mentioned by the IEA in their latest update as the reason for raising their 2022 global oil demand growth forecast by 380k barrels per day to 2.1 million barrels per day. Since the report was published the incentive to switch has increased even more, adding more upward pressure on refinery margins, so called crack spreads (EU diesel crack shown below as an example)
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
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