Oil seeks support in mid-40s, hawks spook gold

Ole Hansen - Broad-based weakness saw the Bloomberg Commodity Index challenge the lower end of the range that has persisted for the past 14 months. The index, which covers the performance of 22 major commodities split equally between energy, metals, and agriculture, remains challenged by bulging crude oil stocks, China’s monetary tightening/growth slowdown, and a fading Trump trade. Selling across the energy sector extended into a fourth week as production from the US, Libya, and Nigeria continued to reduce hopes that Opec will be successful in bringing down global inventories within the expected timeframe. Precious metals were caught off-guard by a hawkish tilt in tone from the Federal Open Market Committee as it raised rates for the fourth time since December 2015. Gold was left exposed following a record three-week surge in speculative demand, during which time it reached but failed to breach $1,300/oz. Soft commodities suffered the most, with sugar hitting a fresh 15-month low after losing 30 per cent of its value over the past four months. Cotton’s mid-May surge continues to deflate in response to expectations for higher output in the 2017-18 season. Excellent growing conditions in both India and the US have triggered this change in sentiment. The growing season in the US can be very volatile for the three major crops: corn, wheat, and soybeans. Weather developments receive a lot of attention due to the alternating demand a growing crop has with regard to hot, dry, and wet weather conditions. US crops rallied recently as a strong heatwave struck, only to see a reversal as new forecasts saw lower temperatures and rain coming. During the next weeks, crop conditions and fund positioning will play important parts in the price performance. Every Monday until October, the USDA will release its weekly crop condition report measuring the health of the crop by ranking in percentage the crops which are in “good” to “excellent” condition. The current conditions of all three crops are currently trailing last year, not least spring wheat which saw the percentage drop to just 45 per cent, its worst rating since 1988. This development was the main factor behind the strong performance in CBOT December wheat this past week. Crude oil returned to the May low this week as rising production and inventories received all the attention. This came following four weeks of selling in the aftermath of Opec and non-Opec members’ best (but failed) efforts to support the price by announcing a nine-month extension. Additional pressure on Opec was piled on by the International Energy Agency; in its forecast for 2018, the US body saw production growth from non-Opec producers alone as able to meet global demand growth. With this in mind, the market is growing increasingly worried as to whether the cartel — with support from Russia and others — will manage stick together until the hard data begins to improve. The risks to an oil recovery are plenty and the battle between supply, demand, and inventories looks likely to see oil lower for even longer than previously expected. Some of the current drivers are: n Rising production from Libya and Nigeria, together with the United States, continuing to offset Opec’s rebalancing efforts. n An escalation to the current Qatar tension risks breaking up the Opec agreement. n Following a weak first half, the full-year projection for demand growth may be at risk. n Some key factors include efficiency gains in the auto industry together with demand concerns, especially in the United States and China. n Central banks’ removing/reducing stimulus could lead to lower speculative appetite From November to April the net production decline between Opec (excluding Libya and Nigeria) and the US (including Libya and Nigeria) was less than 400,000 barrels/day. This just goes to show the (so far) limited impact of the production cuts currently in place until next March. However, with crude oil once again trading back to the mid-40s the risk of supply destruction will begin to receive some attention. US production has risen by an average of 10,000 barrels/day on a weekly basis during the past eight weeks. Over the previous eight weeks, the average weekly rise was above 30,000 b/d per week. Further support should come from lower Opec supplies during the current peak domestic demand season. US shale producers are low on hedges into 2018 as they have reduced selling in the expectation that the downside risk would be limited due to Opec cutting production. The price of WTI crude oil for 2018 has fallen by 14 per cent from the elevated average seen between November and March. A prolonged period of price weakness will eventually impact weaker producers’ ability to stay profitable and the rapid growth in production seen of late may once again falter. Gold investors and traders were spooked by the hawkish tilt presented by Federal Reserve chair Janet Yellen following the latest US rate hike. Coming just a few hours after data had shown weakness in both CPI and retail sales, the hawkish tone caught the market off guard. Another waiting game can now be expected as traders turn to incoming economic data to see whether the Fed’s bullish outlook and the planned speed of subsequent rate hikes can be justified. We still expect the upside to be broken eventually but potentially not before we see a bigger stock market correction. Real money investors are buying gold in order to achieve diversification from such an event. On that basis, a positive performance of gold is not the only parameter for these investors to get involved. The latest correction back in May triggered increased physical demand as gold retraced to the $1,220/oz area. From a technical perspective, support in gold can be found at $1,245/oz and the price needs to hold $1,227/oz, the uptrend from January, in order to maintain the bullish skew, which we eventually believe will result in the yellow metal breaking higher. [Ole Hansen is head of commodity strategy at Saxo Bank]