Gold as well as silver traded slightly higher on the week despite some midweek softness after the FOMC delivered nothing new and U.S. stocks challenged support. While the Fed has promised rock-bottom rates for longer than three years, the initial cross-market reaction with lower stocks and a stronger dollar raised some concerns that the Fed’s tool box has started to look empty, with the element of surprise no longer there.
In a recent update we described gold as looking passive as its movements have been mirroring those seen in U.S. stocks. The lack of fresh input from bonds and the dollar has meant that algorithmic trading systems, often trading correlations between markets, have moved to the driving seat, thereby creating an unusually positive correlation between gold and stocks. Correlations work as a trading strategy to a point. With this in mind, the very short-term direction may be dictated by the stock market.
However, our long-term outlook remains supportive. The combination of inflation protection attracting demand, the outlook for a weaker dollar and the positive views on when a vaccine against Covid-19 will become available are all too optimistic. With these developments in mind and the potential for a very ‘ugly’ U.S. election period ahead, we maintain our bullish outlook for gold. Meanwhile, in the short term the performance of U.S. mega-caps and the dollar hold the key to the direction. As a result, we are likely to see the two-month consolidation period being extended further.
Crude oil found a bid following the recent sharp correction and break below the trend that had prevailed since June. Driving the recovery has been upbeat economic data from China and the U.S., the world's biggest consumers, along with a general improvement in the risk appetite after U.S. mega-cap stocks found support.
Most important, however, was the strong verbal intervention given by Saudi Energy Minister Prince Abdulaziz bin Salman following the OPEC+ meeting this past week. He opened the meeting with a forceful condemnation of members that try to get away with pumping too much crude. He went further during the Q&A session with a journalist by warning short sellers not to challenge the Kingdom’s resolve by saying, “I’m going to make sure whoever gambles on this market will be ouching like hell”.
While potentially a sign of frustration that OPEC+ production cuts have yet to deliver a strong recovery, the minister was probably also trying to prevent increased short selling amid what OPEC, the IEA and BP call a fragile demand recovery at a time of very high spare capacity and inventories. Since July when fundamentals, but not the price, started to weaken the gross short held by hedge funds in WTI and Brent crude oil has more than doubled to 235 million barrels.
While short sellers may move the market for a short period of time, fundamentals will always be the main driver. And while the recent 15% correction in Brent crude oil helped to bring the price more in line with current fundamentals, a recovery from here needs more than verbal intervention, despite it coming from the world’s biggest producer.
We remain cautious about crude oil’s short-term ability to rally much further unless OPEC+ surprises the market in abandoning its planned 2 million barrels/day production increase set for January. While the U.A.E., a major laggard in August, will cut production again, some concerns linger with regards to Iraq and Libya. Iraq has, according to tracking data, increased its production this month while Libya’s ceasefire may support a recovery from the current sub-100,000 barrels/day of production.