- A weaker dollar and short-covering in energy and metals offset reversal in grains
- Yellen comments helped trigger short-covering in gold and silver
- Crude oil up after week of mixed signals
- All three major crops hit after a strong early July surge
Oil prices remain stuck between contradictory forces of improved inventory data
and persistently high output and weak compliance with Opec curbs. Photo: Shutterstock
By Ole Hansen
The commodity sector got a lift as the US dollar weakened further. Short-covering in energy and precious metals helped offset a sharp reversal in grains as recent weather concerns eased.
The end of ultra-loose monetary policy took its next step when the US Federal Reserve was joined by the Bank of Canada which raised its official interest rate
on Wednesday for the first time in seven years, up a quarter point to 0.75%. Fed chief Janet Yellen said in her semi-annual testimony to Congress that while the Fed continues to bring interest rates gradually back to normal, it could adopt a slower approach if inflation remains below its target.
Yellen's comments on Wednesday and Thursday combined with weaker-than-expected US CPI and retail sales data on Friday helped attract some short-covering in gold and silver, thereby raising the prospect of a renewed recovery in both.
Crude oil traded higher after a week of mixed signals, with the International Energy Agency seeing rising demand growth, but also rising Opec production and lower compliance with agreed production curbs. In the US, another bigger-than-expected stock draw was offset by a pick-up in production after five weeks of no change.
The roller-coaster ride that often occurs in key crops during the volatile growing season continued this week, but this time in reverse. Selling hit all of the three major crops after a strong early July surge led by high-quality spring wheat on weather concerns and the reduction of a record short soybean position.
The selling accelerated after a monthly supply-and-demand report from the US Department of Agriculture showed relatively robust global stockpiles of the crops. Adding to this was a change in the short-term weather outlook towards slightly cooler temperatures and chances of rain.
December wheat and November soybeans futures traded in Chicago
Source: Saxo Bank
Three weeks of improved US oil stocks data have so far been offset by price-negative news coming from Opec. The International Energy Agency's put it this way in its latest monthly energy report: "Each month something seems to come along to raise doubts about the pace of the re-balancing process. This month, there are two hitches: a dramatic recovery in oil production from Libya and Nigeria and a lower rate of compliance by Opec with its own output agreement."
While seeing a pick-up in global demand growth, the IEA also said that Opec's rate of compliance dropped to a six-month low last month, to 78% from 95% back in May. Adding to worries was a combined 700,000 barrels per day production increase from Libya and Nigeria — both exempt from cutting — so the cartel's efforts remain challenged.
The problem for Opec was clear to see in its own first forecast for 2018 demand. An expected rise in global demand of 1.26 million barrels per day was met by only a slightly smaller increase in non-Opec production of 1.14 million b/d. Based on these assumptions, it will be hard for Opec to discontinue its production cuts after March 31 as it would risk flooding the market with unwanted oil once again.
The persistently large overhang of global supply combined with the slow reduction currently seen has sharpened the focus on the need for a lower price for longer. This is required to affect high- cost US shale oil producers' ability or willingness to keep adding rigs and boosting production.
However, after staying flat for the past five weeks, US oil production jumped 59,000 b/d last week to 9.39 million b/d, the highest since July 2015 and just 213,000 b/d below the record from back then. US shale oil producers meanwhile have been adding eight new rigs on a weekly basis since hitting a low point last May, and this pace shows no signs of slowing.
The short-term outlook for oil remains challenging, with the best chance of recovering being an unforeseen event that forces a reduction in the near-record short position now held in WTI and Brent. A sustained recovery back towards the higher end of the established range, however, would require several of the following to unfold:
- Slowing US rigs and production growth in response to lower prices
- Strong seasonal reduction in US crude oil stocks (normally runs until end-September)
- Opec maintains discipline, especially from Iraq and Iran
- Key Opec members reduce Q3 exports to meet increased domestic consumption
- Slowdown in or renewed disruptions to production growth from Libya and Nigeria.
We maintain a bullish outlook for this quarter in the belief that several of the above may unfold over the coming weeks. Until such time, however, oil bears are likely to remain in control, which is until the spell of lower highs, as seen since February, is broken.
On that basis, we focus on resistance at $47.3/b in WTI and $50/b in Brent as being key levels going forward.
Gold and silver saw prices make a tentative recovery after an accelerated selloff the previous week. Yellen's semi-annual testimony to Congress helped attract some short-covering in gold and silver, but both remained vulnerable given the outlook for higher rates. Weaker than expected retail sales and CPI on Friday gave both metals a further boost as it help send the Japanese yen higher and bond yields lower.
The massive jump in negative yielding debt at the beginning of 2016 helped drive the first-half surge in gold back then. With increased focus on central banks normalising monetary policy, gold and silver have run into some headwind as bond yields began climbing, thereby reducing the outstanding amount of debt trading at negative yields.
The changed outlook in central bank behaviour has triggered a sharp reduction in hedge funds' involvement. During the past four weeks, funds cut bullish bets on gold by 78% to 38,000 lots, a near 15-month low. The reduction has been driven by a sharp increase in the gross short, which jumped one-third to an 18-month high in the week to July 4.
Bullish silver bets hit a record 99,000 lots back in April, but bets have returned to neutral during the past four weeks, with the gross short hitting a record 58,000 lots.
These important tactical and often short-term developments in hedge funds' behaviour once again stand in sharp contrast to the behaviour of investors using exchange-traded products. Despite the recent price weakness, the total holdings in gold and silver ETPs have seen a steady increase — not least in silver where total holdings reached a new record this week.
We conclude that longer-term investors continue to be attracted to gold and silver as a means of diversification. But we also see confirmation that hedge fund flows remain the most important driver when it comes to short-term price movements.
The break in gold below $1,214/oz last week triggered a technical sell signal based on the double top at $1,295/oz from April and June. The target on this break is $1,133/oz, and it helped attract additional short-selling.
The failure to extend the selling below $1,205/oz has seen defensive action from short-sellers reducing their bets while waiting for a potential second chance. The break above $1,230/oz seen on Friday would - if sustained - send a signal that the selling attempts have failed, and short-covering could see it return to relative safety.
— Edited by John Acher
Ole Hansen is head of commodity strategy at Saxo Bank