The commo-dities sector, led by energy, continues to see demand during the first full trading week of 2018. The sector has been benefiting from an increased focus on inflation as the current expansion cycle moves toward its late stage where price pressures tend to build.
As a result, the rally during the past month has pushed the broad-based Bloomberg Commodity index (BCOM) and the energy-heavier S&P GSCI to levels last seen in 2015. With crude oil and gold representing 46 per cent of the exposure in the S&P GSCI and 27 per cent in the BCOM, any demand from index investors will benefit these two commodities more than most other commodities.
A correction in gold after a $95 non-stop rally remains elusive, and, after a brief pause, the yellow metal continued its ascent while clocking up the longest run of weekly gains since last April. The metal is being driven higher by investors focusing on increased inflation risks and the weaker dollar, not least against the yen. These developments more than offset a continued surge in global stocks and heightened bond market volatility. The latter has come in response to a stark reassessment of the anticipated policy path of both the Bank of Japan and not least the European Central Bank.
Brent crude oil reached $70/barrel ahead of US president Donald Trump’s long-awaited decision on whether to waive sanctions against Iran or step away from the deal and reintroduce sanctions. The latter could trigger a price-supportive slump in Iran’s oil exports, thereby prolonging the sequence of multiple supply disruptions witnessed since last October.
Natural gas surged more than 11 per cent but remains stuck in a one-year range around $3/therm. A record weekly stock draw of 359 billion cubic feet is being offset by record production and a near-term outlook for warmer weather.
Cotton surged to a seven-month high ahead a US government report that was expected to cut US ending stocks amid higher exports. Other agricultural commodities remained under pressure due to abundant supplies. While most energy and metal commodities currently trade above their 200-day moving averages, most farm commodities, with the exceptions of cotton and livestock, trade below as abundant supply continues to attract speculative short-selling from funds.
Gold resumed its rally as the dollar hit a three-year low against the euro and a six-week low against the Japanese yen. The December 13 dovish rate hike from the Federal Open Market Committee followed by the US tax reform helped reverse gold by weakening the dollar while raising inflation expectations.
Volatility returned to bond markets, with the yield on US 10-year treasuries reaching 2.6 per cent, the highest since March. Concerns are being raised that the bull market in bonds, which has lasted for more than 25 years, could be coming to an end. Overall, however, real yields, an important driver for gold, remain range-bound, with rising US nominal yields offset by rising inflation expectations as shown by the breakeven yield below.
We maintain a bullish outlook for gold into these early stages of 2018, with the yellow metal targeting resistance at $1,350/oz followed by $1,375/oz, the 2016 high. But after a $95 rally from the December 12 low, a correction bigger than the $18 seen this week is probably what the market needs to gain the confidence required to push the price higher.
Crude oil continued higher, but just like in 2015 the psychological $70/b on Brent crude combined with a record reading for the relative strength index (RSI) helped trigger some profit-taking. WTI crude oil almost made it to $65/b, the highest level since December 2014.
Multiple realised and unrealised supply disruptions together with falling US and global inventories all helped propel crude oil higher in recent months. Missing from the equation, however, has been the elusive corrections once supply disruptions either faded or failed to materialise. This highlights the current sentiment and bullish traders’ ability to protect a record long position of more than one billion barrels.
A combination of elevated refinery demand and lower imports has seen US oil and product stocks approach the five-year average. The strong momentum of the past six months has resulted in the biggest accumulation of long positions on record. In the week to January 2, hedge funds held a speculative long in crude oil and products of close to 1.2 billion barrels, with WTI and Brent longs representing the bulk of this exposure.
Developments related to Iran were behind the latest run-up in oil prices. Countrywide unrest at the beginning of the year was followed by attention to the January 12 deadline when President Trump is to decide whether to certify Iran’s compliance with the nuclear deal and thereby continue to waive the sanctions that were lifted after the deal in July 2015. Stepping away from the agreement between Iran and five other nations could trigger a unilateral reintroduction of sanctions against persons or organisations, which could hamper Iran’s ability to maintain — let alone expand — its production.
Continued high compliance has left the risk to Opec’s overall production level skewed to the downside, not least due to current and potential future developments among the five weakest producers. For instance, Venezuela remains on the brink of collapse. Lack of funding and new investments have led to a steep decline in the national oil company’s ability to produce and ship crude oil.
Contrary to what the market is now telling us, we maintain the view that the job to create a balanced market is not yet done. We see short-term and longer-term challenges to the prevailing bullish sentiment. In a macro perspective, we see the risk of growth disappointing as central banks begin tapering their accommodative policies. The growth seen during the past few years has been driven by credit, and as central banks start to raise the cost of money, global growth and demand for oil could begin to suffer.
Support from declining US stocks should also begin to fade as both crude oil and gasoline stocks tend to rise during the first quarter of the year as demand from refineries and drivers slows. Lower imports and rising exports of crude oil have, however, helped extend the period of price-supportive stock draws.
Ole Hansen
(Ole Hansen is head of commodity strategy at Saxo Bank)
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