Head of Commodity Strategy
Summary: Commodities traded lower for a second week with US and China struggling to get a trade deal across the finish line. Gold found support at a key level while a week-long oil rally ran out of steam with OPEC+ under pressure to cut production further.
The Bloomberg Commodity Index, which tracks the performance of 22 futures markets across energy, metals and agriculture traded lower for a second consecutive week. The global growth outlook and with that future demand for many key commodities remain challenged by the prolonged trade war between the U.S. and China.
With the negative impact on trade becoming increasingly apparent, both sides have been signaling a willingness to reach an agreement. So far however, getting past the goal line with a light phase one deal has so far proved difficult. As a result, several markets have witnessed dump and pump behavior with the price action being determined by the ebb and flow of trade news from Washington and Beijing.
Growing expectations that a deal will be reached has triggered record stock levels in the U.S. and rising bond yields while the Federal Reserve has signaled a pause on further rate cuts. Most recently Larry Kudlow, the White House economic adviser, said negotiations on a first phase deal had entered the final stages. We are however concerned that the eventual result may struggle to live up to market expectations. Further uncertainty lies ahead with the low point in U.S. and Chinese growth most likely still in front, not behind us.
On that basis we continue to favor precious metals over growth-dependent commodities such as energy and industrial metals.
Gold took a tumble during the past couple weeks as the market continued to adjust to a continued rise in global stocks and a sharp recovery in global bond yields. Hedge funds, which tend to be the fastest out of the block when it comes to responding to a change in the technical and/or fundamental outlook, cut their net-long by 21% ahead of the latest downside extension. The combination of elevated traded volumes and a record level of open interest in COMEX gold futures highlights the current battle between long and short positions which are both on the rise. Buyers no longer hold the control they had just a few months ago and nervous trading lies ahead while the market responds to trade news and movements in stocks, bonds and the dollar.
The trigger for renewed gold strength however hinges on the outcome of the current trade talks and incoming economic data from the major economies. While we believe the market may have acted prematurely to the prospect for global growth to recover, a renewed push remains unlikely to happen before year end. We are entering the annual period of “window dressing” where gains are being defended while decisions about new positions are being postponed. Unless a strong signal emerges like last year’s December stock market sell-off.
Using Fibonacci retracement levels gold has reached its first key level of support just below $1450/oz. A level that represents a 38.2% retracement of the $1266/oz to $1557/oz rally seen between May and August. From a bullish and longer-term perspective, the key level to focus on remains $1380/oz, the old ceiling which capped the upside from 2016 and June this year.
The rally in High Grade copper, a bellwether for global growth and demand, has run out of steam after being rejected at $2.725/lb, a level corresponding to its 200-day moving average. Social unrest in Chile, a major producer, and the prospect for a trade deal helped drive a short-covering rally since early October. But with short positions now much reduced, further upside hinges on whether real demand emerges following a deal, especially from China.
Crude oil has, just like copper, been trading higher since October with the prospect for a trade deal, the Aramco IPO and signs of slowing U.S. output all providing support. Overall, we maintain the view that Brent crude oil is unlikely to break away from $60/b anytime soon. The long-awaited Aramco IPO has finally arrived with the initial public offering of a small fraction occurring inside Saudi Arabia. While the initial sale of a small quantity is likely to be very successful given the incentives being offered to residents the real challenge will not occur until the next phase when the bulk of the offering goes on sale internationally.
In order to ensure a successful sale and valuation, the Saudis need to maintain price stability and preferably higher prices, something that at this stage would require additional production cuts after the International Energy Agency in their latest Oil Market Report said that OPEC+ faces a “major challenge” in 2020 from competitors surging output. A development which they say would require another substantial production cut from the OPEC+ group of producers in order to keep the market balanced.
Supporting oil into 2020 is a growing belief that non-OPEC production may struggle to deliver the expected rise with U.S. shale oil production growth being increasingly called into question. While we see the potential for higher oil prices this time next year the short-term outlook remains challenged, with or without a trade deal. The so-called Aramco Put which focus on Saudi Arabia’s resolve to support prices at or above $60/b is still at risk of being tested over the coming weeks and months. Much hinges on what signals the OPEC+ group sends to the market when they meet in Vienna on December 6.
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