Head of Commodity Strategy
Summary: Big swings in several commodity markets this week on the swing from fear to hope, driven by geopolitical tensions easing and consolidation after a run higher in the US dollar. The next week looks key for cementing whether the recent reversal in the price action is a brief stumble or something more significant, particularly in the biggest move in the commodity space of late, precious metals.
Commodities traded higher for a second week with energy and industrial metals catching a bid while the weeklong rally in precious metals paused. The week and the month of September kicked off with the market taking stock of the September 1 increase in tariffs by both the U.S. and China. This resulted in the markets hitting a level of peak pessimism last Tuesday with the dollar temporarily breaking higher while safe -haven metals, led by silver and platinum surging higher.
Calmer conditions in Hong Kong, reduced risk of a hard Brexit and news that the US and China have agreed to resume talks in early October all helped kick off a major risk on rally. US stocks and bond yields both broke higher thereby pulling the rug from underneath precious metals. Gold witnessed the biggest one-day drop since the election of President Trump in November 2016 while silver and platinum, the recent highflyers, dropped hard after almost hitting $20/oz and $1000/oz respectively.
Agriculture commodities traded lower for a fourth week with the upcoming US harvest adding stocks to an already oversupplied market. The UN’s Food and Agriculture Organization raised its forecast for global grain production for the 2019-20 season which includes the southern hemisphere harvest in early 2020. Such news is particularly troubling for US farmers as they struggle to ship their stock abroad amid Chinese tariffs and the strong dollar diverting overseas buyers to South America and Europe instead.
Gold suffered its biggest one-day setback since November 11, 2016 following the election of President Trump. The weakness occurred after gold had made three failed attempts to break above $1550/oz. The profit-taking that followed turned into a rout as US stocks and bond yields both broke higher. Previous bull markets in gold, most noticeable the one from 2000 to 2010, were littered with aggressive corrections which, despite the strong gains during that decade, made it a very difficult market to trade for short-term tactical traders.
Despite being a painful experience for recent buyers, we view the upside potential as being enhanced by such a correction. The reasons why gold and other metals have rallied hard since early June have not gone away. Bonds worth trillion of dollars trade with a negative yield, the global economy is still slowing and the European Central Bank on September 12 as well the US Federal Reserve on September 18 look set to provide additional stimulus through rate cuts and renewed quantitative easing.
While a further deterioration on the trade front between the US and China looks unlikely before they meet in early October, we still view the path to a solution as being very long and difficult. China wants calm into the National Day Golden Week and 70th anniversary of the PRC on October 1. What happens afterwards remains to be seen, especially given the need for compromise, something that neither side has shown much appetite for up until now.
From a technical perspective, a drop to $1450/oz will be viewed as a weak correction within a strong uptrend. Only a break below $1380/oz which coincides with the ceiling that prevailed for almost five years up until June would change the outlook to neutral.
We maintain a bullish view on gold with the short-term focus on US economic data and central bank meetings before the focus returns to trade in October.
HG copper hit a 28-month low following the September 1 tariff increase and strong dollar before mounting a recovery to reach resistance at $2.65/lb. The recovery from what turned out to be a false breakout was driven by short covering from funds reacting to news about the resumption of trade talks. The upside potential, apart from additional short covering at this stage, however, remains limited with economic growth and demand concerns weighing.
Crude oil reacted in the same fashion as copper with initial weakness being replaced by a strong rally. While the technical outlook shows sign of improving, both WTI and Brent crude continue to struggle to breaking away from $55/b and $60/b, respectively. The spread between the first month and deferred contracts remains firmly in backwardation, normally a sign of a price supporting a tight market. However, while the present supply and demand situation provides support, the market remains concerned by the risk of what lies ahead. Not least, the ongoing risk to demand growth should the economic slowdown develop into a recession.
Increased non-Opec production from the U.S. to Brazil and Norway looks set to create an oversupplied market into 2020. A development which depending on the level demand growth could force the Opec+ group of producers to extend production cuts indefinitely. Production surveys from Reuters and Bloomberg both found that Opec raised production last month for the first time since last November.
Despite these headwinds, crude oil, supported by another drop in US stocks, managed its biggest weekly rise since July. While the longer-term fundamental outlook remains challenging, the short-term technical outlook show signs of improving with Brent potentially targeting $65/b as the next level.
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