By Ole Hansen
The excitement that ripped through the commodity space following the election of Donald Trump last November in the US and Opec’s agreement to cut production helped trigger a dramatic increase in speculative demand which lasted well into February.
What became increasingly apparent during the first quarter, however, was the lack of price momentum to justify this bullish buildup in speculative bets. As the quarter ended oil was back under pressure with Opec and non-Opec production cuts diluted by increases elsewhere.
Trump-based exuberance had begun to fade on doubts whether he would be able to get his growth policies through Congress.
The Bloomberg commodity index – a basket of major commodities – has been trading sideways for the past year and renewed weakness, especially in crude oil, during March finally triggered a record amount of selling from funds.
The second quarter is unlikely to be the turning point for the index as multiple risks persists within the different sectors. The dollar could end up providing some support with the bullish momentum continuing to fade, not least against the two major currencies of euro and Japanese yen.
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Crude oil fundamentals are not yet strong enough to support a sustained recovery. This became apparent during the first quarter when oil met firm resistance above $55/barrel despite the support from funds which at one stage held bullish bets exceeding 1 billion barrels.
Opec and non-Opec members efforts to curb production received a lot of positive attention. The realisation, however, that the process was being hampered by lack of compliance from individual members and rising production elsewhere, helped trigger some renewed weakness.
The fragile sentiment which resulted in a sharp correction during March is unlikely to go away any time soon. Opec is potentially being forced to extend current production cuts beyond six months to achieve its goal of balancing the market.
Can Saudi Arabia hold the Opec deal together? Photo: Shutterstock
But an extension of the deal would require Opec and non-Opec producers to agree. There have been signs of frustration from Saudi Arabia related to slow compliance from Russia and Iraq. The question remains how a deal would survive for a full 12 months given the signs of unease less than 12 weeks into the deal.
In the US, production continues to increase on a weekly basis. The number of oil rigs are back to September 2015 levels while wellhead breakeven prices have fallen and production per rig is going up. With more than 35% of the 2017 production already hedged (source: Goldman Sachs), a downside move has to be substantial in order to change the current outlook for rising US production.
Source: Saxo Bank
Our $50/b before $60/b call on Brent crude oil was met during the first quarter and with the road to recovery continuing the be extended, we believe the best the market can hope for in Q2 is for Brent crude to stabilise around $50/b but cannot rule out a temporary drop to $45/b. We lower our year-end forecast to $58/b in the belief that demand growth and supply cuts eventually will positively impact the price.
Gold once again saw selling pressure ahead of a US rate hike but just like the previous two hikes in December 2015 and 2016, the announcement marked a low point from where buyers returned. Following a strong beginning to the year on raised geopolitical concerns, both in Europe and the US, both gold and silver were sold heavily ahead of the March 15 Federal Open Market Committee meeting.
The feared hawkish hike failed to materialise with the FOMC maintaining its outlook for just two more rate hikes in 2017 followed by just another two in 2018. In signalling a steady course ahead with inflation and growth outlook subdued, both metals received a boost from both a weaker dollar and bond yields as well as signs that Donald Trump’s honeymoon with the markets was being challenged.
Investors have maintained a lukewarm attitude to gold with a rapid build-up in speculative longs in January and February reflating very quickly ahead of FOMC. This does indicate that gold needs to see the bullish dollar and bond yield expectations fade more than they have already.
Political risks such as the upcoming French election are eyed closely by gold investors as well.
On the other hand, the world is currently facing a collection of geopolitical risks which in numerical terms are the highest we have seen for a long time. This situation is likely to continue to attract demand from investors looking for diversification and a hedge against unforeseen events.
Industrial metals are showing signs of weakness, despite multiple supply disruptions hitting copper especially. Hedge funds net-long positioning in silver is three times greater than the five-year average while for gold it is half. Considering these developments, we may see silver struggle relatively to gold. The gold-to-silver ratio has so far this year been trading between 68 and 72 and we may need to see it revisit the higher end of this range to attract additional interest.
Source: Saxo Bank
We maintain our end of year forecast for gold at $1,325/oz and based on a pick-up in industrial metals we could see silver reaching $19/oz.
— Edited by Michael McKenna
Ole Hansen is head of commodity strategy at Saxo Bank