By: Ole Hansen
Head of Commodity Strategy / Saxo Bank
Commodities traded flat on the week as a third weekly gain in energy was offset by profit-taking in metals, both precious and industrial. Some of the key drivers behind these developments were increased demand for oil, rising US inflation, North Korean missile fatigue, and weaker economic data from China
The metal weakness was partly to blame on the dollar recovering after hitting a 2½-year low. At least some of the firming was a product of US President Trump’s political pivot on deal-making with the Democratic leadership in Congress. This raised the prospect of him not only having turned a corner but potentially being able to reopen his efforts on tax reform and infrastructure spending. From a dollar perspective the most important factor could be any agreement on repatriation of foreign corporate profits.
Apart from the stronger dollar several weeks of fund buying in both gold and copper had left both metals exposed. They were challenged as US inflation surprised to the upside and Chinese economic data to the downside. The safe-haven trade looked tired after another notch up in geopolitical tensions failed to lift gold and JPY.
Industrial metals including copper went into reverse following a strong quarter which saw the Bloomberg Industrial metal index rise by almost 25 per cent. The rally in industrial metals since May coincided with a rally in the Chinese yuan which lasted until this week when Chinese policymakers relaxed rules from October 2015 which had been put in place to discourage speculating against the yuan.
A weaker yuan (stronger dollar) combined with a set of weaker than expected data on Chinese retail sales and industrial production added to the weakness. Bullish fund bets had reached a record high and the pressure from long liquidation could see HG Copper retrace back to $2.91/lb or potentially as low as $2.83/lb.
Crude demand rising
WTI crude oil traded higher for a second week and fully recovered the selloff that was triggered by the collapse in demand caused by refinery disruptions in the aftermath of Hurricane Harvey. Monthly oil market reports from Opec and the International Energy Agency both painted a rosier picture for oil, with demand growth rising and the global overhang of oil and fuel supplies, courtesy of supply cuts from Opec and non-Opec (primarily Russia) beginning to approach the long-term trend.
Opec pumped 32.76 million barrels per day last month according to the cartel’s latest Monthly Oil Market Report. Based on the projected global supply/demand balance for 2018, Opec would be required to supply 32.8 million barrels/day. On that basis it is no surprise that Opec members have already openly begun discussing the need for an extension once the current deal expires next March.
Such a decision may cause internal problems as some producers are desperate to increase production and revenues. But the risk that failure to extend could send prices sharply lower should ensure its safe passage.
A WTI crude oil price at or below $50/b has hurt US shale oil producers’ ability to continue ramping up production. The EIA sees US production averaging 9.3 million barrels/day in 2017 and rising to average 9.8 million bpd in 2018, a small reduction from recent updates. The rally in WTI crude oil helped support a pick up in hedging activity from US shale oil producers, the bulk of which require a price of $50/b or higher to maintain, let alone increase production.
Brent spread with WTI to narrow
Backwardation in Brent is consistent with a tightening global oil market, while contango in WTI is consistent with local oversupply of crude as a result of refinery shutdowns and the closure of export terminals. As a result, Brent’s premium over WTI is currently elevated above $5/b. But once the impact of hurricanes begins to fade, we should see the spread start to narrow, but whether it is Brent falling towards WTI or WTI rising towards Brent, or a combination of both, remains to be seen.
The improved technical and fundamental outlook for crude oil may attract some additional short-covering and new longs in the short-term. But having retraced in full the August selloff we remain sceptical about how much further upside can be achieved at this stage – not least considering the potential for increased selling from producers.
Gold ran into selling after traders began booking profit ahead of key resistance at $1375/oz, the 2016 high. The weakness then extended as the up until then tailwind from a weaker dollar and stocks and lower bond yields began to fade. Trump’s beginning to act as a president and traders getting less excited about North Korea’s provocations added to the weakness.
From the low point in July gold had rallied 150 dollars during which time hedge funds made a ten-fold increase in bullish futures bets to a near record. On Thursday the US Labor Department data showed a surprise pickup in inflation last month which raised the likelihood of more tightening from the US Federal Reserve.
Faced with a band of resistance between $1337/oz. and $1342/oz. gold is back on the defensive with the focus once again turning to the critical support level at $1300/oz. While North Korean missile launches are receiving less attention that will quickly change if they start hitting anything else than just ocean.
Considering the build up in speculative long positions the short term risk has been skewed to the downside. But while long liquidation can take it lower towards the uptrend from July the underlying reasons for holding gold, such as diversification and safe-haven demand, remain. We see the current weakness more as consolidation than a change in direction.
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