• Weak USD provides tailwind for commodities
• Chinese environmental plans could impact demand
• Silver struggling to keep up with gold
By Ole Hansen
The commodity sector enters the final quarter of 2017
on a much better footing after following improved performances during the third quarter. The dollar continued to weaken and that provided a general tailwind to most sectors, not least metals.
Crude oil recovered as weather-related disruptions combined with Opec and non-Opec producers’ efforts to curb production finally began helping global balances. Developments in China saw industrial metals advance as growth data and a stronger yuan increased demand, both speculative and real, while environmental policies helped curb supply.
Precious metals traded higher as an escalation in
global tensions increased demand for safe havens and diversification. The two-steps-forward/one-step-back, however, continued with profit-taking hitting the market after a $150 rally which helped trigger a surge in speculative demand.
Agriculture commodities continued to struggle as another
year of crop-friendly weather ensured robust production, not least in grains where silos were left full with new supply struggling to find strong enough demand.
The positive price action, however, is unlikely to be
replicated during the final quarter as the dollar may pause while fundamentals may not yet be strong enough to support a continued rally, especially in growth-dependent commodities such as oil and industrial metals.
Much depends on the 19th Congress of the
Communist Party in China which begins on October 18. The market will be paying close attention to the Party’s priorities and growth prospectives for the coming years. Fighting pollution and maintaining financial stability could have a negative impact on both real and speculative demand for commodities traded on Chinese exchanges, particularly bulk and industrial metals.
Bloomberg commodities index:
Source: Bloomberg, Saxo Bank
Geopolitical risks remain a threat to the global economy and the potential impact on supply – and demand – for key raw materials. On trade, US president Donald Trump’s focus on a fair deal for US producers could still result in US trade policies turning more protective which undoubtedly could lead to various trade wars breaking out.
Key drivers for gold
The deteriorating relations between North Korea and the rest of the world are a clear and
present danger while simmering tensions in the Middle
East cannot be ignored. The increasingly hazardous geopolitical landscape together with oft-irrational behaviour and comments from the US president have provided precious metals, not least gold, with constant and underlying support from investors seeking to protect tail-end risks in the market.
This, combined with the weaker dollar and a benign outlook on global rates, inflation and growth will continue to support the sector into year-end. We have made no change to our end-of-year call on gold at $1,325/oz since it was made last December and we see no developments at this stage warranting a revision.
Other drivers for gold, apart from the dollar and yields
stripped of inflation are the general commodity price trend as well as confidence in the political and financial system. On balance we find that the bulk of these will continue to provide underlying support for precious metals into 2018.
Investment demand, especially from hedge funds, ebbs and flows and often creates elevated
and unsustainable positions. Corrections can often be
quite substantial but as long they amount to less than 61.8% of the latest move the market will remain in good shape.
Silver has struggled to keep up with gold and the gold/
silver ratio shows how has been trailing gold for most of the year. Being a semi-precious metal with close to half its demand deriving from industrial users, this performance is particularly disappointing. But it highlights how a great deal of gold demand this year has come from investors seeking to hedge tail-end risks.
During such times, silver tends to struggle relative to
gold as its high beta and lower liquidity are not the best qualities for someone looking for a safe haven. We see silver at $17.35/oz at the end of the year.
Key drivers for gold:
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Source: Bloomberg, Saxo Bank
And as for oil...
The crude oil market looks set to finish 2017 on the
best footing since oversupply helped trigger the 2014 selloff. The impact of production cuts implemented this year by Opec and non-Opec producers have finally begun reducing the global overhang of crude oil supply.
The drop in US fuel stocks after Hurricane Harvey
's disruptions to the Texan Gulf coast will continue to affect refinery margins positively and keep demand for oil elevated at time when a seasonal slowdown normally occurs.
Rising production from Libya, Nigeria and not least US
shale producers helped create a great deal of headwind during the first half of the year. The subsequent price weakness is likely to have negatively impacted US supply by more than expected while both Libya and Nigeria will both struggle to increase supply much further from here.
Refineries have postponed maintenance to benefit from
the elevated margins that followed Hurricane Harvey. In the month after the hurricane disruption US stocks of gasoline and diesel dropped by 24 million barrels compared with a five-year average rise of 2.5 million.
Opec and non-Opec producers will be pleased about
the widening gap between WTI crude and Brent crude oil, close to $6/b at the time of writing. The return to backwardation in Brent crude not only increases revenues for producers using the spot price as settlement, but it also helps attract demand from financial investors taking advantage of the positive roll yield.
WTI crude oil languishing at a discount close to $6/b helps prevent US shale producers from accelerating production.
Click to enlarge:
Source: Bloomberg, Saxo Bank
The outlook for crude oil demand into 2018, however
, does not leave any room for Opec and non-Opec countries to increase production and an extension of output curbs beyond March will be needed to ensure continued support for the oil market.
Given the pull from increased refinery demand, we see
Brent crude oil ending the year around $55/b, while WTI crude oil will struggle to climb much higher than $51/b given its positive impact on supply growth from US producers.
Going into 2018 much depends on whether robust
demand growth can be maintained. Given our concerns about US and Chinese growth (see the introduction from Saxo chief economist Steen Jakobsen
), we could see demand growth disappoint and on that basis we are not yet prepared to call a halt to the range-bound nature that has prevailed throughout most of 2017.
— Edited by Michael McKenna
Ole Hansen is head of commodity strategy at Saxo Bank