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. 

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK Limited
Rooms 2001-02, 20/F York House
The Landmark
15 Queen's Road Central
Hong Kong

Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: Rooms 2001-02, 20/F York House, The Landmark, 15 Queen's Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.