- Major commodities hit by long liquidation as investors forced to cut exposure
- Crude oil pundits wonder whether $70/b was a step too far, too soon
- Gold corrects lower in response to a stronger dollar and hawkish rate outlook
Natural gas was among the hardest hit in a week of commodity woe. Pic: Shutterstock
By Ole Hansen
The global market has been spooked by recent developments in the US where rising wage pressure at a time of low unemployment and tax cuts is raising concern. The S&P 500 entered into correction territory after falling 10% from its January 26 high, and with bonds also falling, commodities suffered another week of sharp losses.
Major commodities, from gold and copper to crude oil, all got hit by long liquidation as investors were forced to cut exposure amid changes to the short-term technical and fundamental outlook.
According to the latest edition of The Economist
, the US has embarked on an extraordinary economic gamble which is potentially putting its economy at risk. The delivery of a huge fiscal stimulus through tax cuts towards the end of the current expansion cycle risks leaving the US battling with rising interest rates and inflation and the need to fund increased budget deficits.
Crude oil was heading for the worst week since last March as months of supportive bullish news gave way to surging US production and a seasonal slowdown in refinery demand. These developments finally forced money managers to cut what had become an unsustainable long position. While the fundamental outlook has improved during the past six months due to production cuts, supply disruptions and strong demand, the question that is now being asked is whether $70/b was one step too far at this stage.
Gold corrected lower for a second week in response to a stronger dollar and speculation that US rates may have to increase faster than previously expected. The turmoil in global stocks help offset some the selling pressure and investors who bought gold in recent months in response to increased market complacency was rewarded with an – if not absolute – then at least a relative performance compared with other asset classes.
Copper slumped for a second week to the lowest since December 15 as funds continuing to scale back bullish exposure amid the ongoing stock market turmoil, a stronger dollar and rising inventories at warehouses monitored by the London Metal Exchange. Risk aversion and the need to reduce risk supported short-covering across the agriculture sector with both grains and soft commodities going against the trend of price declines.
The Opec+ group's so far successful attempt to curb global production in order to support the price has become unstuck. Once again it is the response from non-Opec producers that have caught the market by surprise. In its latest monthly outlook the US Energy Information Administration lifted the prospect for US oil production growth further. Having broken the 10 million barrel/day mark the Administration now expects to see US production exceed 11 million barrels/day this November, one year earlier than previously expected.
The selloff accelerated following the weekly US stock report which showed a second weekly rise in US crude oil stocks. Further evidence of the beginning to the seasonal slowdown in refinery demand – due to maintenance – which normally runs until April. The weekly crude oil production estimate was lifted by 332,000 barrels/day to reach 10.25 million barrels/day thereby exceeding Saudi Arabian output for the first time since 1990.
While supporting a strong recovery in global crude oil prices since last June, Saudi Arabia and its Opec friends, together with Russia, are now beginning to pay the price in terms of lost market share to non-Opec producers. More important in the short term is the risk of prices also beginning to suffer from the boost to non-Opec production mentioned above.
One of the interesting features seen during the multi-month rally in oil has been the raised hedging activity carried out by swap dealers on behalf of oil producers. As a result, we ended up with a record long being held by speculative accounts and a record short held by swap dealers.
During the rally, this resulted in buyers and sellers having no problem finding the opposite side. A correction, however, breaks down this relation with the short position being in no hurry to cover. That risks create uneven market conditions, which is why oil long liquidation phases can be quite painful.
Continued weakness in global stocks is likely to add to the nervousness currently creeping into the market and we maintain the view from our Q1 outlook, called "How to spot a bubble", that Brent crude could be exposed to a 10-15% decline this quarter.
This could see Brent crude oil make a return towards $60/b before stabilising within a $60-$70 range.
The correction seen so far in Brent and WTI can extend further without risking a change to the technical outlook which above $61/b would still "only" be described as a healthy correction within a strong uptrend.
Gold continued to pare back some of the strong gains seen during the 130-dollar rally between December and January. Seven consecutive weeks of buying and the failure once again to establish support above $1350/oz left it vulnerable to a correction as risk aversion rose amid a crazy spike in stock market volatility.
Despite trading lower, gold's activity was relatively calm compared to what unfolded in both bonds and stocks. Rising US interest rates and dollar short covering are likely to provide some headwinds in the short term. But an increasingly clouded outlook for the US economy, geopolitical concerns and the risk of further stock market losses are likely to provide continued support to gold.
We see a reduction in the open interest in Comex Gold futures to the one-year average as a sign that most of the long liquidation that was needed has now been carried out. From a technical perspective the next key level of support can be found at $1300/oz. The level that must hold in order for the bullish sentiment being maintained is $1285/oz while a break above $1343/oz could signal a renewed attack on the recent highs.
The weakness among industrial metals also negatively impacted silver with the gold-silver ratio breaking above 80 for only the fourth time in 20 years. Palladium was another metal that was hurt by raised risk aversion. The combination of low liquidity and a very elevated speculative long position saw its premium over platinum return to flat for the first time since September.
– Edited by Clare MacCarthy
Ole Hansen is head of commodity strategy at Saxo Bank