Head of Commodity Strategy, Saxo Bank Group
Summary: The Fed- and China-fueled risk rally has boosted commodity prices despite evidence of a global slowdown.
The recent change in tone from not only the Fed but also central banks in China, Australia and Europe highlights nervousness about the increased risks to global growth and the need to arrest the slide towards recession. A US recession probability index issued by the New York Fed has risen to the highest level since 2008 while economic data in China continue to deteriorate.
A warning that things may get worse before improving was found in the Chinese manufacturing PMI which fell more than expected to a three-year low. In Europe, Italy fell into recession for the first time since 2013 while the UK economy starts to feel the pain of the Kafkaesque political situation surrounding Brexit.
The strong returns in commodities witnessed during the early parts of January faded somewhat during the final week. Despite one of the coldest winters on record in parts of the US, natural gas priced out of New York nevertheless slumped by more than 9%.
Crude oil, meanwhile, remained rangebound after failing to receive a ‘lower-supply-driven’ boost from US sanctions against Venezuela’s state oil company and Saudi Arabia saying they were cutting production by more than they had agreed to.
Iron ore initially surged by more than 15% following the disastrous dam burst in Brazil. The facility run by Vale, a top global producer, forced the company to suspend 40 million tons/year of production (this sounds like a lot, but it only accounts for 0.2% of annual seaborne trade). Gains were pared towards the end of the week as the production impact was reassessed and after a continued drop in the Baltic Dry Index pointed towards a potential weakening in demand for transport of iron ore and coal.
Gold reached a nine-month high at $1,325/oz after the Fed returned to a neutral stance on rates. It concluded a two-month, $110 rally which was supported by the worst December drop in US stocks since the 1930s. It continued into January after Powell’s January 4 speech in which he made a significant U-turn by acknowledging that the Fed was open to ending quantitative tightening faster than anticipated while saying that it was also the listening to the market’s call for a pause in interest rate hikes.
Gold’s ability to move higher this month despite a strong recovery in global stocks highlights the continued appetite for tail-end protection amid macro-economic and geopolitical worries. Following the US government shutdown, the weekly Commitments of Traders report, which provide insights about speculative positions held by money managers, is not expected to return to normal until early March. This pause in data has left the market somewhat blind in terms of gauging how the major players see the landscape.
Data covering demand for exchange-traded funds backed by gold however continue to show strong demand. During the past two months, total holdings have risen on all but four days to reach 2,280 tons, a near six high.
Having reached $1,325/oz, gold once again needs to consolidate, potentially back towards $1,300/oz. However we maintain an overall bullish outlook and at this stage would only express a correction view using put options.
Crude oil posted its strongest monthly advance since 2015 but despite multiple events and comments providing support it failed to break higher. Having been rangebound for the past three weeks, the short-term direction could be lower as both WTI and especially Brent continue to consolidate within the established $5 ranges. During the past week, the following comments and events failed to give oil the needed boost to break higher.
• US sanctions against PdVSA potentially reducing crude oil exports further
• Saudi Arabia said in an interview that it would cut February production below its voluntarily agreed limit at 10.33m b/d
• The Fed joined other central banks in turning more dovish thereby supporting the growth and demand outlook.
• US weekly crude oil inventories rose by less than expected as Saudi Arabia cuts supplies
• Stabilising risk sentiment with trade talks between China and the US appearing to gain some momentum
WTI crude oil is currently stuck in a $50/b to $55.50/b range.