WCU: Oil prices falter as macro fears rise

Commodities 10 minutes to read

Ole Hansen

Head of Commodity Strategy

Summary:  Crude oil appears poised for a decline as macroeconomic concerns move to the forefront.


Global commodity prices stayed on the defensive for a second week with losses seen across all sectors apart from precious metals and livestock. The global central bank policy panic that emerged in the US following the December stock market thrashing spread to Europe as Thursday’s European Central Bank meeting saw the bank slash its (still overly high) growth forecast while delivering fresh stimulus. 

Global growth is slowing and a trade deal between the US and China is unlikely to “save the world” at this stage. It may even create some disappointment given how much markets have rallied ahead of the expected announcement. China, the growth engine of the world, has seen its growth targets being reduced while February exports slumped the most in three years. 

On Friday, the CSI 300 index dropped 4% after the market interpreted a rare sell rating from the nation’s largest brokerage as a sign that the government wants to curb excessive gains of close to one-third since early January. 

The Bloomberg G10 currency index rose 0.7% while EURUSD, the world’s most-traded currency pair dropped to €1.1180, a 21-month low before recovering following a weaker-than-expected US job report. The Japanese yen, meanwhile, stood up to the dollar and rallied against all Asian and G10 currencies on renewed safe-haven demand.
Bloomberg Commodity Index
Source: Bloomberg
The energy sector traded lower with only gasoline and natural gas managing to hold onto small gains. Opec+ production cuts, a big seasonal drop in US product stocks and continued concerns about developments in Venezuela have so far prevented bullish funds from hitting the sell button. However, with the mentioned risk of lower growth leading to lower demand we see the risk increasingly skewed to the downside. 

The US Commodity Futures Trading Commission has finally caught up following the December-January government shutdown. From the week ending March 5, the Commitment of Traders reports covering positioning in commodities, forex, bonds and stock index futures will once again be “live” and actionable. 

The last delayed report, covering the week to February 26, highlighted the dismal sentiment across key agriculture commodities. With sugar, bean oil and live cattle currently being the only such commodities showing positive returns this year, it is no surprise to find hedge funds (bar a few exceptions) holding elevated net-short positions across the sector.  

The grain sector in particular needs supportive news as the global overhang of supply continues to weigh. At the time of writing, the market was awaiting a monthly supply and demand report from the US Department of Agriculture. 

The reason why we primarily focus on hedge funds is because they are likely to have tight stops and no underlying exposure that is being hedged. This makes them most reactive to changes in fundamental or technical price developments. It provides views about major trends but also helps to decipher when a reversal is looming.
Funds positioning
Source: Bloomberg, Saxo Bank
Weaker stocks, lower bond yields and a stronger Japanese yen helped gold recover despite the headwind from general dollar strength, especially against the euro. Key support at $1,276/oz has so far not been challenged but at this stage a recovery back above $1,305/oz is needed to attract renewed demand and short-covering from hedge funds, who according to recent COT reports were wrong-footed near the recent high. 

In the week to February 19 when gold surged higher, they increased their net-long by close to 4.5 million ounces (45,000 futures lots). Investors in exchange-traded funds backed by bullion have reduced total holdings on a near-daily basis since January 31.

Central bank demand for gold, meanwhile, seems set to continue. Following the strongest year of buying since the early 1970s, the recent weakness is likely to have attracted continued demand for reasons that vary from so-called de-dollarisation – reducing dependence on the dollar – to worries about rising macroeconomic and geopolitical pressures. While Russia, Turkey and India were big buyers in 2018, China has now bought 29 tons during the past three months following a hiatus of more than two years.

Gold traders remain nervous following another of numerous failures to break higher since 2016. However, having retraced less than 38.2% of the August-February rally, the market remains in an uptrend and only a break below $1,254/oz will change the status back to neutral. 
XAUUSD
Source: Saxo Bank
We view the sideways trading in crude oil during the past three weeks as potentially building up to a correction. During this time, the market has received plenty of supporting news such as falling production from the Opec+ group of producers, increased hopes for a trade deal and not least the deteriorating situation in Venezuela. 

The weakening global growth outlook has been less of a focus given robust forecasts for global demand growth. This may change after the OECD lowered its global growth outlook this past week, saying that “vulnerabilities in China, Europe and financial markets could derail the global economy”. Next week the EIA, Opec and IEA will all deliver their monthly oil market reports and the market will be looking out for any potential downgrades to demand.

In the US, crude oil production has reached a record 12.1 million barrels/day. The Federal Reserve Bank of Dallas’ recent energy update survey found that US shale oil producers in the high-growth area around Permian, Texas need less than $50/b to break even on new wells.

Operating expenses on existing wells in the same area, meanwhile, are covered as long the price stays above $30/b. 

The break below $55.5/b on Friday could see WTI crude oil target $52/b ahead of the big level at $50/b.
Crude oil
Source: Saxo Bank

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