Complex Made Simple

Oil and gold trending up: time for optimism?

One-third of the UAE’s GDP depends on oil exports. So, rising prices benefit local economy’s bottom line

By Jameel Ahmad, Chief Market Analyst at FXTM

West Texas Intermediate (WTI) Crude Oil has encountered a positive beginning to the month of March, breaking through the critical psychological resistance barrier of $35 that we have been closely monitoring since the end of January 2016.

This increases the confidence that the commodity might be signalling an escape away from the previous bottom that it found in February – after failing to close weekly trading above $35 in the final weeks of January.

The moves we have seen in WTI have largely been promoted by the technical charts. However, the world is still monitoring the fundamental outlook that is still being dominated by concerns over an aggressive oversupply in the market.

Some have taken optimism from the announcement that OPEC members have agreed to “freeze” production levels; however, I wouldn’t read too much into this news as the production output levels of OPEC members have crept towards near-record highs over previous months.

Basically, concerns about the fundamental oversupply in the market will continue to linger in the atmosphere. In fact, OPEC’s crude oil supply rose by 1.7 million barrels per day in January on the back of Iran’s output, according to the latest International Energy Agency (IEA) report. Also, reports have circulated widely that Iran will not be joining any possible production freeze when its own economic sanctions have only just been lifted.

As we approach the conclusion to trading for Q1 2016, we believe that the price of WTI should continue to recover losses as long as $35 is used as a stubborn support level. The $35 rate should now transfer itself away from previously being seen as psychological resistance to psychological support, which should also encourage optimism around the markets that the price of WTI can now begin to at least recover its dramatic losses.

I expect for a close above $35 during the first trading week of March to lead to WTI hitting $38 and at least attempting a run towards $40 before the month is complete.

At this point, only news regarding a production cut or the emergence of a correlation at last between consistent declines in the drilling of US oil rigs and weekly inventory reports from the United States should lead to a further bullish reversal in the price of WTI.

The arguments against that scenario are the persistent concerns over a slowdown in global GDP (Gross Domestic Product), particularly when it comes to the UAE’s Asian trading partners Japan, China and India. One-third of the UAE’s GDP depends on oil exports. So, a rise in the oil price benefits the local economy’s bottom line.

Japan imports more than 80 per cent of its oil from the Middle East, with the UAE being the second-largest supplier after Saudi Arabia. Japan’s GDP is projected to grow by a relatively bearish 1.7 per cent in 2016, according to the World Bank. Full-year GDP growth in China is expected at seven per cent, and in India the World Bank estimates growth at 7.9 per cent, so any downside growth developments in Asia could have an impact on the oil price and growth in the UAE.

Bullish gold

The second red-hot trend on the markets is the bullish gold price, which broke through the critical pivot level of $1,200 at the beginning of February and hasn’t looked back since.

At the time of writing, the gold price is heading towards $1,280 per ounce and has gained by $178 since the beginning of the year. Risk appetite is creeping back into the major equity markets, but the rising gold price signals a prevalent trend towards a cautious hedging of this risk.

What is interesting to me personally is that, despite investor appetite towards the equity markets returning, we are not seeing profits being taken on gold. This suggests to me that there is still some investor caution in the market.

The fresh demand indicates benefits for the UAE’s gold trade; Dubai is an international hub for gold trading, processing an estimated 40 per cent of the world’s physical gold. The increase in the gold price would put more taxes in the state’s coffers and contribute to GDP at a time where government revenues would be suffering from a dramatic reduction in the price of oil.

An important factor in the gold price is the Federal Reserve’s position on raising US interest rates. The more dovish the Federal Reserve, the more bullish the gold price as investors cool off towards the USD.

Federal Reserve Chair Janet Yellen is watching the same indicators as the rest of the investment world; Non-Farm Payrolls (NFP), Consumer Spending, Durable Goods Orders, and Purchasing Manager Indices in the manufacturing and retail sectors. January’s NFP was less-than-impressive at 172,000, while February’s was much more bullish at the level of 242,000, showing a mixed picture of the US employment market in the first two months of 2016.

Investors still haven’t warmed up to the USD in spite of February’s higher-than-expected jobs numbers and the Federal Reserve’s intentions for 2016 are coming under heavy scrutiny, providing further encouragement for gold. The central bank’s outlook for 2016 remains cautious, warning of less supportive economic conditions in the US. On the upside, global GDP is seen as picking up over time, supported by more accommodative monetary policies, according to Yellen’s last speech.

Gold hasn’t lost its safe-haven appeal and the next major economic event that may contribute to further gains is the UK’s vote on June 23 to stay in or out of the European Union. If Britain votes to end its membership in the EU, there will be significant economic repercussions in terms of reducing the benefits of free trade and export costs in the UK.

Reduced trade with the EU bloc may also have a knock-on effect on the UK’s target of increasing trade with the UAE to £25 billion by 2020. In the event of a Brexit, on the upside, expanding into new markets like the UAE will become more of a priority. On the downside, without the EU free trade discounts, the UK may find itself with less economic power to offer attractive and competitive export prices.

Wrapping up, these red-hot trends could continue into the second quarter, although it’s reasonable to assume a possible decline in the gold price if the Federal Reserve ups interest rates against expectations in March.

In the case that the UK votes to stay an EU member in June, the risk appetite may improve and the gold price could fall accordingly. The oil price could be bumped up by firmer positions on limiting supply or pushed down if global stocks keep brimming over and investor sentiment turns sour once more.

(£1 = $1.44 = AED5.28, at the time of publishing)