Commodities remained exposed to broad-based selling this past week. For a third consecutive week, the sector struggled to put up a defence against the challenging combination of rising US interest rates, a strong dollar and the global equity rout, which has now spread to the US market.
The Bloomberg Commodity index, which tracks a basket of key commodities in energy, metals and agriculture, was down 2 per cent on the week, with losses in energy, industrial metals and grains offsetting renewed safe-haven demand for precious metals, led by gold.
The global rout in stocks has spread to the US with the major indices having seen their gains for the year wiped out. The Nasdaq index, which contains several of the technology bellwethers, is currently on track to record its worst monthly performance since the Global Financial Crisis in 2008.
Financial markets are waking up to the fact that the strength of the so-called central bank “put” is weakening, as QT (quantitative tightening) in the US slowly begins to drain the excess dollar liquidity that global markets have thrived on for the past decade. During this time volatility stayed compressed in the belief that any weakness in bonds and stocks would be bought as the above-mentioned excess liquidity needed to find a home.
On that basis the focus in commodities has turned to the risk of an economic slowdown negatively impacting the demand outlook into 2019. Most noticeable has been the dramatic turnaround in crude oil these past few weeks. As October began there was much talk about supply and the risk of surging oil prices before year-end given that US sanctions against Iran are scheduled to come into full force from November 5.
The risk of a major reversal already became clear in early October when Brent crude oil broke above $80/barrel and surged to almost $87/b. During this rally, hedge funds turned sellers, especially of WTI crude oil, instead of buying into the strength as they normally do. It highlights once again how crude oil is often traded with a macroeconomic view instead of one purely focusing on crude oil supply and demand fundamentals. As the price of oil rose so too did the risk to the outlook for demand, with many emerging market economies already being troubled by a heavy load of dollar debt at a time of rising funding costs and a stronger dollar.
Three weeks later and following an 11 per cent slump Brent crude has fallen back to support at $75/b. The pledge from Saudi Arabia to pump as hard as possible is going a long way to calm any worries about supply shortages over the coming months. Opec has even raised some concerns that the market could end up being oversupplied as we are entering the seasonal slowdown in global demand.
Brent crude oil has made a swift return to $75/b, a level around which it pivoted for several months before the break higher last month. A break below could see it target $70/b while $80/b has once again been established as resistance.
As per our recently released Q4 Outlook we believe the “lower growth leading to lower demand” narrative eventually will take its toll on crude oil prices. However, we also believe that the market may have jumped the gun too soon with the supply disruption impact from Iran not yet fully known. Opec’s and especially Saudi Arabia’s pledge to “produce as much as they can” could backfire should the need for additional barrels rise by more than expected.
In such a circumstance the market will begin to worry that lower spare capacity would leave the market exposed in the event of production outages from other producers such as Iraq, Venezuela, Libya and Nigeria.
Overall it is our belief that the above uncertainty is likely to provide some short-term support once the panic selling is over. With $75/b now acting as support, we see Brent crude oil making its way back up towards $80/b in preparation for US sanctions taking their full toll on supply.
Gold benefits
The month-long sell-off in gold increasingly looks like it’s over with the yellow metal focus having switched from the headwind of a stronger dollar to the tailwind being created by renewed safe-haven demand in response to the global market rout in stocks. This change has further been supported by demand for Japanese yen and US government bonds where the yield on 10-year notes has fallen back below 3.1 per cent.
Given gold’s relative strong performance so far this week (+0.8 per cent) despite the stronger dollar (+1 per cent ) it is likely that resistance at $1,240/oz could be challenged and broken very soon. Not least considering continued stock market weakness on Friday following disappointing results from technology behemoths Amazon and Alphabet.
Gold’s weak performance was until recently strongly linked to the direction of the yuan, which has fallen by 7 per cent so far this year. That correlation is now fading with the rout in equity markets and lower bond yields attracting a safe-haven bid that so far has proven to be stronger than the headwind caused by the dollar reaching the highest level since June 2017.
Staying with the Chinese renminbi, our Head of Forex Strategy John Hardy warned in his latest update that we have “peg-like” setup with a break above the pivotal 7.00 dollar level likely to push market volatility into overdrive. He wrote:
“The recent USD strength is pushing very hard on the USDCNY exchange rate and the CNY, or renminbi floor that has been established by China ahead of the 7.00 level is suppressing volatility in currencies as the world watches and waits whether the world’s most important exchange rate will remain contained.
As China is the world’s biggest importer of raw materials, a shift in its currency could have major ramifications considering the current trade war. A weaker yuan is likely to attract a response from the US and with that the risk to global growth will only strengthen.
(By Ole Hansen - Head of Commodity Strategy at Saxo Bank)
Oman Observer is now on the WhatsApp channel. Click here
