Head of Commodity Strategy, Saxo Bank Group
Summary: The ongoing risk rally, abetted by central bank and government action, is the dominant factor in the commodities space.
Central bank and government action has in recent weeks provided market-supportive fiscal and monetary stimulus. These developments have supported a 28% surge in the CSI 300 index since the beginning of January. Adding to the bullish sentiment this week was confirmation from the MSCI that it will raise the weight of Chinese stocks in its global emerging markets index.
Strong US data helped send yields higher and the Japanese yen to a 10-week low at ¥112 to the dollar, thereby supporting the risk-on sentiment. US inflation expectations, meanwhile, continued to climb higher towards 2%, raising some early warning signs that the market’s dovish belief in no further US rate hikes may be challenged sooner rather than later.
So far, these developments (especially in China) have led to speculation about increased demand for industrial metals while easing fears about slowing demand growth for crude oil.
After reaching a six-year high on January 31, total holdings in bullion-backed ETFs have since seen a continued decline throughout February.
While gold’s six-month rally showed signs of pausing, platinum has picked up the baton to emerge from gold’s shadow. The combination of the continued rally in palladium and a record discount to gold has helped attract renewed (speculative) demand. During the past two weeks, the discount to gold has collapsed by more than $80 to $440/oz. The white metal is not facing the same amount of strong resistance that has helped trigger profit-taking in gold.
Gold has gone looking for support after breaking the uptrend from November. The first level of support at $1,300/oz is followed by the more important $1,275/oz – a level that represents the January consolidation low and the 38.2% retracement of the August to February rally.
Supporting the rally has been a recent decline in copper stocks held at London Metal Exchange-monitored warehouses to the lowest since 2005. While this has created a sense of tight supply, we have simultaneously seen a strong increase in deliverable stocks at the Shanghai Futures Exchange.
HG Copper is showing signs of consoldation and with that the risk of a short-term reversal towards the highlighted area below $2.8650/lb.
Following the initial sell-off, the market quickly recovered after comments from the Saudi Minister of Energy saying that the current production cut deal could be extended into the second half of the year. The minister is playing it safe with this comment to make sure that the market refrains from selling oil in response to rising US shale production and before the price-supportive tightness becomes visible in the data.
In addition, Russia’s Energy Minister Alexander Novak was out saying that Russia has cut output by close to 150,000 barrels/day and that it will reach its 228,000 b/d target by early April.
The extent to which Opec has cut production in recent months was seen in the monthly production survey carried out by Bloomberg. In February production from its members slumped by 560,000 barrels/day to 30.5 million barrels/day, a near four-year low.
On the back of this observation and a continued drop in open interest on the Brent futures contract since February 15, we suspect macro funds have started to fade (sell into) the current rally in the belief that economic headwinds may offset the positive impact of production cuts.
Macroeconomic uncertainties still exist but the drumbeat of worsening economic data has so far been difficult to hear amid all the hype about the potential positive impact of a trade deal. We suspect that most of the positive impact of a deal has been priced in, particularly considering that global stocks have returned to their pre-trade war levels – an unsustainable height given the raised recession risk currently emerging across the world.
Despite supportive fundamentals, as supply tightens we see the short-term risk of a deeper correction than the one seen post- the Trump tweet. Just like gold has broken its uptrend, the same could happen to Brent crude on a break below $65.30/b. This would potentially create a period of consolidation with support at $64/b and ultimately $60/b being tested.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)