By Ole Hansen
Commodities have become increasingly challenged as we enter the second half of 2018. Following a strong start to the year we have seen multiple headwinds begin to emerge during the past quarter. Above all we find a real threat to global growth and subsequent demand for many key raw materials from the rising probability of a trade war between the US and many of its key trading partners, most importantly China.
Trade wars tend to be a losing strategy as raised tariffs results in lower trading volumes and growth while increasing the cost to consumers around the world.
The current robustness of the US economy compared with the rest of the world has led to a divergence in monetary policy between the Federal Reserve and other major central banks. This has resulted in a stronger dollar, which is piling additional pressure on indebted EM economies having to fight harder and pay a higher price for funding as global dollar liquidity becomes tighter.
Emerging market growth drives demand growth for many key commodities from industrial metals to energy, hence the importance of current developments.
One of the exceptions has been crude oil, which despite recent efforts from Opec and Russia remains bid amid the rising threat to short-term and long-term supplies from a range of producers including Venezuela, Libya, Canada and not least, Iran.
The surging dollar, both against EM and DM currencies, has resulted in gold surrendering its safe haven status, at least for now, to the greenback and US treasuries. Industrial metals have come under pressure from mounting challenges to the Chinese economic outlook from a combination of trade war and slowing credit growth.
The rally across key agriculture products at the beginning of the year became unstuck as traders took fright from trade war tensions which have put US exports of corn to Mexico and not least soybeans to China at risk. This development has together with the adverse impact of a stronger dollar and improved US growing conditions triggered a spectacular collapse in fund positions across the three major row crops of corn, wheat and soybeans.
During the past week both industrial and precious metals as well as agricultural commodities have continued lower as trade war concerns and negative price momentum continued to attract fresh short-selling.
WTI crude oil, meanwhile, spiked higher to reach levels last seen in 2014. Brent and WTI both received a boost when Washington turned up the pressure on Iran after demanding that all allies should reduce their imports of Iranian oil to zero after November. In addition, WTI crude was supported by the biggest stockpile drop in almost two years, rampant refinery demand and news that a one-month outage at a Canadian oil-sands producer could further reduce stockpiles at Cushing over the coming weeks.
The weekly petroleum status report from the EIA provided a smorgasbord of bullish news for oil. Crude oil stocks dropped by almost 10 million barrels on combination of record exports and record refinery demand. The accelerating stock draw at Cushing, Oklahoma, the delivery hub for WTI crude oil futures supported a strong rise in the prompt spread on tighter supply concerns while almost halving the discount to Brent crude oil.
At the center of attention over the coming months will be supply and potentially the lack of it. Despite the fact that the world’s three largest producers – Russia, Saudi Arabia and the US – are all taking aim at producing 11 million barrels/day each, several producers are struggling and could see its production slide further.
US sanctions against Iran after November 1 are expected to sharply reduce that country’s exports as customers around the world seek alternative suppliers for fear of US retaliation. Venezuela continues to see its oil industry collapse while recent fighting in Libya has once again highlighted the risk to its 1 million barrels/day production, currently down by 300,000 barrels/day.
Higher fuel costs, trade wars and a slowdown in global growth may eventually halt the oil market rally as attention turns to lower demand growth. When this shift will happen and how high oil can rally before it occurs is anyone’s guess. Not least considering the elevated level of political interference currently impacting the oil market.
A recent Reuters survey of 35 economists and analysts forecasts that Brent crude will average $74/b during the second half of 2018, somewhat lower than current spot price of $79/b. From a charting perspective Brent crude oil looks likely to breach $80/b again before finding resistance ahead of $82/b.
Gold’s performance turned sharply lower during June as the yellow metal struggled to find a defence against the stronger dollar and Fed chair Jerome Powell’s hawkish stance on continued normalisation of US rates. Nine months of gains were reversed after traders grew increasingly frustrated following gold’s inability on multiple occasions to break key resistance above $1,360/oz.
Investors seeking a safe haven against a whole host of macroeconomic, financial and geopolitical risks have instead been turning to the dollar and US treasuries for protection. With this bid missing and the dollar moving higher, gold has been acting just like another risky asset in recent weeks. As the technical outlook deteriorated funds stepped up their short-selling of gold with the net-long dropping to a 2½-year low on June 19.
Longer-term investors who often express their bullish gold view through exchange-traded products cut their total holdings by 44 tons, the most since last July.
Central bank divergence is supporting a stronger dollar through a widening yield gap to other major currencies. Trade tensions and the risk of a slowdown has seen the Chinese yuan weaken by a 3.3% during June. The below chart shows a strong correlation between the yuan and gold and until the currency stabilises the upside to gold looks limited.
Gold and semi-precious metals are currently looking for support and from a longer-term perspective the area just below $1,240/oz is likely to be the next key battleground as per the chart below. Silver, meanwhile, has maintained a relatively stable ratio to gold, an indication that most of the weak longs have been cut by now.
Given the strength of the June sell-off gold needs to retrace back above $1,270/oz and potentially even $1,286 before recently established shorts begin to exit and fresh buyers return from sitting on the fence.
Rising inflation risks from trade wars and signs that several major economies are heading for a slowdown are good enough reasons for us to refrain from turning bearish on gold at this stage. While the short-term technical outlook is challenged and could lead to further losses, we see renewed upside risk once the dollar rally pauses and/or data begins to support our above mentioned view on inflation and growth.