Complex Made Simple

Oil and gold prices continue to rebound

As the commodity markets move into the month of May, WTI crude oil prices are continuing to rebound as expected after breaking through the critical psychological resistance level of $35 per barrel in March. Crude is now heading for a second straight month of gains, with the next important benchmark seen as $50 per barrel – OPEC’s target for 2016.

While there’s a seeming divergence between the fundamental oversupply versus the current market sentiment pushing prices upwards, this is partly explained by the steady increase in global demand for oil, as forecast by the IEA in 2016. Another factor contributing to rising oil prices is the steadily shrinking level of drilling rigs in the US, which reached a six-year low at the end of April as more and more of them are being taken out of production.

As expected, during April, the oil price did break through the $42 to $44 cap, seen as the range of technical resistance. There was a dip down towards $35 just after the anticlimactic OPEC meeting in Doha, but this was seen as a support level, rather than the psychological resistance level it was several months ago.

It was always unrealistic to expect OPEC to agree so quickly on freezing the oil supply, thereby increasing demand, especially in the light of the various conflicts of interest between the members. Iran is flexing its muscles now that it’s back on the international oil markets, resisting Saudi Arabia’s call to fall in line with OPEC’s objective of limiting the supply.

Given all the drama around Doha that unfolded in the world media and trading markets, it was easy to forget OPEC’s long-term strategy of allowing oil prices to fall and squeeze out competing non-OPEC producers, while pressuring their currencies. The US is a prime example of the success of this strategy, with its own production most recently decreasing amid a subdued USD. US demand is a massive mover of the oil price and the country’s domestic strategy for the past eight years has been to increase production from shale deposits. Does this mean that OPEC is now looking forward to the possible return of the US to the role of a completely net importer?

While it is reasonably clear to latch onto the fact that OPEC’s indirect strategy is to allow prices to remain low in the hope of squeezing out external producers from the market share, with this including the United States, it is interesting to monitor the resilience that US producers are showing despite prices remaining at such prolonged depressed levels. The drilling of US oil rigs is falling to multi-year lows on a near-weekly basis, but we are yet to see this correlate to fewer stockpiles in the weekly US inventory reports. Whether this could be linked to improved technologies or indicates that it is just going to take far longer than expected for this correlation to take place remains to be seen; however, the markets do need a clear and consistent message of this taking place for the persistent oversupply concerns to calm down and for potential buyers to be instilled with encouragement.

What does all this boil down to for the oil price? As the market balances itself out, WTI now needs to close consistently above $44 for technical traders to be enticed towards pricing in further gains. Until then, any failure to close above $44 could lead to a round of profit-taking.  For those wondering what might happen if the commodity does manage to close above $44, well, we are likely to see another rally by a couple of dollars, but profit-taking could then be met around $48 level.

In other developments in the commodity markets, gold is still in strong demand amid fitful bouts of concern over global growth and a dovish Federal Reserve downplaying hopes of an interest rate hike in the short term. Nothing beats gold as a gauge of risk appetite and, with the price moving upwards towards $1,270 at the time of writing, it seems there is still room for the gold bulls to take advantage of market uncertainty.

The level of $1,200 is still the important pivot point in the gold markets. Sellers are likely to be waiting for the metal to drop below this level and maybe to $1,190 before entering selling opportunities. An important consideration is that gold prices have increased by 11 percent in the past six months and, with investors usually very bullish over $1,200, the possibility must be considered that a new pivot level is on the horizon.

What should be made clear is that 2016 has seen the return of investor appetite towards gold and that those previous expectations that the metal could fall below $1,000 appear to have been erased. I am strictly bullish on the metal above $1,200 and am not ruling out the return of $1,300 for gold. If we do manage to extend above $1,300 at some point, it is worthwhile for traders to consider that the level around $1,307 is seen as a huge possible resistance level for gold and this is where investors might decide to take some short-term profits.

Market risk factors pushing the gold price upwards include the UK referendum on remaining in the European Union, the slowdown in the global economy and the lower-than-expected prospects of a US interest rate hike.

Investors can expect continued volatility in the commodity markets and a close eye should be kept on the next developments from OPEC in May.