- Equity surge, weaker dollar and focus on inflation boosted commodities
- We turn neutral on oil after seeing the price almost reach our Q1 objective
- Gold returns to the scene of many bull/bear battles since 2014
Industrial metals, including copper, were the big winners in this week's commodity bonanza. Images: Shutterstock
By Ole Hansen
Renewed risk appetite has been led by the recovery in global stocks which posted their best week of gains in six years. The dollar hitting its lowest level since 2014, together with a rising inflation focus, supported a strong week for commodities with funds continuing to have an appetite for broad-based commodities funds. Gains were seen across all sectors with industrial metals on top ahead of the Chinese Lunar New Year holiday.
Despite rising bond yield differentials increasingly favouring the dollar relative to other major currencies, the greenback continued to weaken. The focus right now is the risk that the massive fiscal stimulus introduced in recent months through tax cuts may eventually hurt the US economy through rising bond yields and rising inflation. Given the inverse correlation between the dollar and commodity prices these developments have created a sweet spot for investor interest in commodities. The broad-based interest was reflected in the synchronised gains seen across the different sectors this past week.
Gold is once again on track to challenge an area of resistance which has been rejected on numerous occasions during the past couple of years. Silver, meanwhile, continues to raise a few eyebrows as it trades at a 22 month low relative to gold despite the strong gains seen among industrial metals.
Crude oil, led by WTI, recovered close to half of its early February slump as the dollar weakened and US weekly inventories rose by less than expected. We turn neutral on oil after seeing the price almost reach our Q1 downside objective. However, a weaker dollar driven by increased concerns about the US economic outlook is not a strong enough foundation from where a price recovery can be established. On that basis we expect the market to remain range-bound for the time being.
Challenging weather conditions in the US as well in South America continue to support the destruction of a fund short position that reached a record just a few weeks ago on January 19. An ongoing drought in Argentina has led to downward revisions to both the soybean and corn crops, while parched conditions in the US plains is likely to reduce the harvest of hard red winter wheat. The Bloomberg Commodity Grains index could potentially begin to challenge the downtrend which has existed since 2012.
Natural gas came bottom of the pile as strong winter demand continues to be offset by record production. With the market running out of heating days to dent inventories further, the risk is that the summer injection season could raise stock levels to a record ahead of the 2018-19 winter season. As a result of these developments Natural gas has slumped by 22% this month and is once again challenging key support at $2.52/therm, a level which has provided support on four previous occasions since 2016.
Source: Bloomberg, Saxo Bank
After falling by more than 12% and after almost reaching our downside target for this quarter, crude oil is showing increased signs of stabilising. However, a weaker dollar driven by increased concerns about the US economic outlook is not, in our opinion, a strong enough foundation from where a price recovery can be established.
During the past week the three most closely watched market forecasters
Opec, the EIA and the IEA all released their monthly updates on the outlook for global supply and demand. While there tends to be a difference in the outlooks, especially between the International Energy Agency (representing consumers) and Opec (representing producers), the trend towards rising non-Opec supply and steady demand continued.
The tightening of the global oil market that followed production cuts from the Opec+ group last year helped support a return to backwardation. Such a situation where the first futures contract trades as the most expensive relative to the rest of the curve, supported a strong and eventually unsustainable accumulation of speculative bets from hedge funds.
The correction seen during the past couple of weeks was driven by the stock market rout and an oil market that had run out of the price-supportive news that was needed to support a speculative bet exceeding 1 billion barrels. Not least after US stocks began their seasonal climb, albeit at a slower than usual pace, and US production broke above 10 million barrels/day.
The chart below shows how the recent correction have failed to negatively impact the price supportive backwardation. Fundamentals, in other words, remain healthy with the biggest risk being the potential need from hedge funds to further reduce exposure.
Hedge funds cut bullish bets by less than 5% in the two weeks to February 6. This was before selling accelerated with data covering the important week to February 13 only being available February 16 after the US close. Oil's ability to stabilise depends on the size of the reduction seen during the week where oil slumped by more than 6%.
Brent crude oil managed to find support ahead of our target at $61/b, the 38.2% retracement of the June to January rally. A correction of this limited size tells us that what we have seen so far is only a weak correction within the established uptrend. Adding the fundamental overlay of rising non-Opec production, crude oil is at best likely to settle into a range with sellers emerging ahead of resistance at $66.50/b on Brent crude oil.
Source: Saxo Bank
Gold traded higher in response to the dual support from a weaker dollar, not least against the Japanese yen, and continued focus on inflation. The latter received additional attention after seeing both consumer and producer prices beat expectations. For now though, gold is primarily a story about the weaker dollar with the recent gold negative spike in ten-year bond yields to 2.9% a four-year high and real yields to 0.8%, a two-year high having limited negative impact.
Gold has once again returned to an area of resistance where several battles between bulls and bears have been fought since 2014. On the previous two occasions in July 2016 and last September the rejection resulted in sharp corrections. With this in mind it is natural to see the market pause once again while trying to gauge whether this time is different. Whether or not that is the case very much depends on the dollar's ability to weaken further while maintaining the theme of rising inflation potentially spiced with geopolitical uncertainty.
Breaking above the 2016 high at $1375/oz could see gold mount an extension towards $1436 and ultimately $1480/oz while another rejection carries the risk seeing a correction to $1330/oz. We maintain a bullish outlook for gold but would use current levels to reduce exposure and either wait for a pullback or a break above $1375/oz to re-enter.
Source: Saxo Bank
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– Edited by Clare MacCarthy
Ole Hansen is head of commodity strategy at Saxo Bank