Oil returned to near pre-Opec levels as the focus on supply outweighed an emerging geopolitical crisis in the Middle East. US inventories of oil and fuel surprisingly jumped and reverted to a three-month high, while output from Nigeria and Libya continued to improve. The Qatar spat has so far been viewed as price negative as it carries a risk of lower compliance or even a collapse of the current deal to cut production until next March.
Gold and silver rallied strongly on multiple uncertainties. But after a dovish European Central Bank meeting, no fireworks from former FBI chief James Comey's testimony and a hung parliament in the UK, the attention turned to booking profits before next week's FOMC.
Industrial metals, with the exception of copper, all traded lower in response to ample and — in some cases — rising supply. A recovery in China copper imports in May, falling LME inventories and supply disruptions in Chile (weather) all helped drive the metal back to the top of its current trading range.
US farmers have had a troubling start to this year's growing season. The weather has gone from too much rain during the planting phase to dryness and extreme heat stressing the crops as the growing process gets under way. Some of the recent buying has been attributed to short-covering from funds holding a record net short position ahead of these latest weather developments. An improved weather outlook for the coming week could halt the rally, but it highlights the risk of price volatility during the important growing phase.
Following a one-month rally of almost 7%, gold broke above its downtrend from 2011 only to find resistance at the April high at $1,296/oz. Ahead of a triple dose of potential risks on Thursday, gold and silver had both received a boost. But as the ECB meeting, former FBI head Comey's testimony and the UK election all failed to rock the boat, the focus instead turned to profit-taking — not least considering the near certain US rate hike on June 14.
Demand for gold as a diversification tool and hedge against political or economic event risks remains. On Wednesday, total holdings in gold exchange-traded funds jumped by 14.5 tonnes, the biggest one-day increase since last July.
Total holdings have now recovered half of what was dumped in the aftermath of last November's US presidential election.
We maintain a positive outlook for gold, but see the short-term risk skewed towards a correction, initially towards $1,265/oz, the 38.2% retracement of May-to-June rally. Only a break below $1,245/oz (61.8%) is likely to attract accelerated selling as seen after the failed April attempt to break above $1,300/oz.
Above $1,300/oz, gold is likely to target $1,315/oz ahead of the November 9 high at $1,337/oz.
Source: Saxo Bank
Renewed tensions in the Middle East have so far failed to add a risk premium to the price of oil.
The Qatar spat once again highlights the sub-surface simmering strife between major producers led by Saudi Arabia and backed by the US on one side and Iran backed by Russia on the other.
In the short term, the market sees a possible escalation of the Qatar quarrel as oil-negative given its potential impact on the Opec and non-Opec producers' ability or willingness to maintain current production cuts. A conflict, however, would undoubtedly become a market-positive factor, as seen in the past, with a risk premium returning in response to fear that supplies from the region could be disrupted.
At this stage, however, the risk to the production cut deal breaking down is seen as a bigger danger than an escalating conflict. The world remains awash with oil, and additional barrels continue to reach the market. This week Royal Dutch Shell announced the lifting of export restrictions, in place for 472 days, from its Forcados oil field in Nigeria. The lifting could see this field increase production to its potential of 250,000 barrels per day.
The Energy Information Administration in its monthly "Short-Term Energy Outlook" has raised its US 2018 production forecast to a record 10 million b/d, which would exceed the previous record of 9.6 million b/d set in 1970. At this stage, given the latest selloff, we believe that US producers may struggle to meet this target due to diminishing economics.
Forward selling by US producers has already begun to slow, with the gross short futures position held by producers falling to the lowest since January. WTI crude oil for delivery in 2018 has fallen by 14% relative to the average seen during the first quarter. Weekly US production growth has slowed to just 1,000 b/d during the past four weeks compared with an average 28,000 b/d during the previous three months.
The combination of supply destruction worries as oil approaches the mid-$40's, rising demand as we approach the traditional strong third quarter demand period and the risk of a Middle East escalation is likely to attract support and reduce the risk of further losses from current levels.
Brent crude remains vulnerable below $50/b, but managed to find support and bounce off the trendline going back to last August. Short-sellers are unlikely to be satisfied by this and are currently targeting $46.65/b, the May low or even $44.66/b, extension target.
Source: Saxo Bank
— Edited by John Acher
Ole Hansen is head of commodity strategy at Saxo Bank