Article / 07 October 2016 at 10:00 GMT

Quarterly Outlook: Green but guarded

Head of Commodity Strategy / Saxo Bank
  • Commodities on track for first yearly rise since 2010
  • Precious metals helped stem rout although gold, silver facing early Q4 tremors
  • Gold slides to the $1,250/oz zone in early Q4 on dollar, Fed double whammy
  • Oil could settle at around the $50/barrel mark after late Q3 Algiers deal
  • Algiers deal still needs huge amount of work before Opec meets on November 30

By Ole Hansen

Commodities remain on track to record their first year of positive returns since 2010. But with the Bloomberg Commodity index up by less than 10%, it could all still change before year-end. While the energy sector continues to stabilise following a two-year selloff, it has primarily been the precious metals sector with its 26% gain that has helped stop the commodity rout.

Global commodity demand has yet to recover as continued questions about global growth are being asked. Instead, most of the gains – apart from those seen in precious metals – have been due to the supply side adjusting, either through cutting production (oil and industrial metals) or through involuntary disruptions caused by weather (softs).  

Oil lower for longer 

From the vantage point of early 2016, the year’s final quarter was widely expected to deliver a firm recovery for oil prices. Prolonged price weakness, it was thought, would ultimately trigger strong demand growth while reducing high-cost production enough to balance the market. Instead, the oil market remains locked in a $45 to $50/barrel range from which it will struggle to escape from into year-end.

Rising Opec supply (both from new production and reduced supply disruptions), together with Russian production hitting new record levels, has once again delayed the rebalancing process. In addition, the past quarter showed emerging resilience among US high-cost producers which are once again adding rigs amid stabilising oil output.

The pump-and-dump strategy introduced by Saudi Arabia in November 2014 was called off at the September 28 when Opec members meeting in Algiers decided to cut production by up to 700,000 barrels/day with the allocation expected to be agreed at the next official Opec meeting on November 30.

The decision was taken to establish a floor under the market with the upside limited until the global overhang of supply start to show signs of being reduced.


There is a lot of detail in the Algiers oil deal to be sorted
out before Opec's November 30 meeting. Photo: iStock

Several questions were left unanswered:

1) Who is going to cut given some members including Nigeria, Libya and not least Iran will be excluded.
2) Who will provide the barrel-for-barrel reduction of the potential increase coming from Nigeria and Libya? 

3) Will Opec actually be up to the task of complying with their decision. Recent history shows that actual production most of the time has exceeded agreed limits.  

4) When will the cuts come into effect? If not agreed before November 30 the impact is not likely to be felt before well into 2017.

The devil's in the details. This was the easy decision compared with the hard bargaining that now lies ahead of the November 30 meeting. If Russia joins, we have a proper deal which could propel oil back to the July level but unlikely higher at this stage.

US producers have been taking advantage of hedging opportunities in 2017 and 2018. Central banks’ experiments with negative yields, meanwhile, have ensured that plenty of investors have been prepared to lend money to the sector. The Opec deal if successful will also cheer US and other high cost producers considering the potential it provides for stabilizing and eventually boosting production.

On top of all this, we still need higher oil prices in the future in order to attract the investments required to ensure stable supplies. Opec producers, led by Saudi Arabia, have shown increased willingness to support the price as the slump has now have lasted much longer and been far more painful than was originally expected.

During the final quarter we expect the $45 to low 50s/b range to be maintained for Brent crude oil. The deal among Opec producers and potentially Russia to freeze or even to cut production is unlikely to have a major positive impact on prices at this stage. It will, however, reduce the time it takes to bring down the global excess supply overhang of both crude oil and products.

b Source: SaxoTraderGO

The lasting impact of such action is not likely to be felt until 2017 on the assumption that global demand growth continues to rise. In a recent report, the International Energy Agency said that oil demand growth from China and India was slowing at a faster pace than initially predicted as underlying macroeconomic conditions remained uncertain.

Hedge funds provided most of the volatility during the third quarter as the rangebound nature created several false signals in both directions. These signals in turn supported the rapid ebb and flow in speculative positioning, which helped create a great deal of volatility. Heading into the final quarter, funds remain overall bullish but the net-long has been reduced by 40% compared the peaks witnessed during April and August of this year.

Precious metals face a volatile quarter 

A US election that remains too close to call, a December rate hike, the direction of the dollar, global bonds, and rising concerns about the negative rate experiment from several central banks...

These are just a few of the themes that gold traders will have to deal with during the coming months.

Gold spent most of the third quarter locked in the range established following the Brexit vote on June 23. As the yellow metal continued to trade within a diminishing range (initially between $1,300 and $1,375/oz), the demand from investors began to fade. Total holdings in exchange-traded products rose by 38% during the first half of the year but have been almost flat since then. Hedge funds have held an unchanged but still elevated bullish bet for the past three months.

More than physical demand, investment demand has been the main driver behind the price surge witnessed earlier this year. While total holdings through ETPs and money managers’ positions in futures have reached a level just 13% below the 2012 peak, the nominal value of this position remains some 35% below.

Gold had been locked in a post-Brexit-vote range but has just
broken out to the downside at the start of Q4. Photo: iStock

The one factor that stands out among the key drivers of the impressive rally seen in gold and silver has been the continued tumble in global bond yields. It has reduced or in some cases even removed the opportunity costs of holding gold compared to low- or negative- yielding secure government bonds.

Other drivers which continue to attract attention have been the market’s obsession with the future direction of US short-term interest rates, the dollar, and the general price trends for the commodity sector as a whole.

We believe that gold’s longer-term direction is higher but the market behaviour during the past few months could indicate that the yellow metal may need a longer period of consolidation such as the current test of key support below $1,300/oz.

From a technical perspective, gold’s post-Brexit rally ran out of steam at $1,375/oz, a level that coincides with a both a trendline from the 2012 peak and a 38.2% correction of the selloff seen up until last December.

An eventual break of this level could see gold initially target an extension to $1,485/oz.

Gold broke below $1,300/oz at the start of Q4 and is right on the key $1,250/oz area triggering an avalanche of long liquidation, something that was needed in order for the market to have any chance of making a renewed attempt to the upside. The rest of October will prove a critical time for gold and one that is likely to determine whether this latest sell-off turned out to be another buying opportunity.
Source: SaxoTraderGO

Until such time, we view the downside risk being the greatest over the coming months. We would view a potential break below $1,300 as a positive development as it would force the market to react and show its hand.

It is often during times of weakness that the true strength of a market can be gauged and following a 23% year-to-date rally, gold may now be in need of such a test.

With our raised concerns that the dollar may regain some strength during the coming months, we look to gold priced in other currencies for upside momentum. According to our forex outlook and intro from Saxo Bank chief economist Steen Jakobsen, some of these alternative currencies could be euro, kiwi, and Japanese yen.

 — Edited by Martin O'Rourke

Ole Hansen is Saxo Bank's head of commodities strategy
07 October
John Roberti John Roberti
dear ole, thank you for your detailed analysis of risks involved with the petroleum stabilization plan. I do believe that we should see, may be next week, a return to 45 or 42 dollar for WTI? What do you think of the EIA last statistics? It seems to me that the report should be helping a decline of prices since it shows that production is stabilised if not ready to go up in the us plus the new discovery in Alaska in shallow depth! furthermore, it seems to me that gasoline consumption in the us is not really increasing despite the season... Am I correct?


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