The month of September yielded no return for the Bloomberg Commodity index. However, behind its flat performance we saw a continued recovery in the energy sector being offset by losses in precious and industrial metals.
The metal sector, not least precious metals, reacted negatively to a hawkish speech from Fed chief Janet Yellen, which left the door wide open for a December rate hike. This was followed by the tax plan announcement from US president Donald Trump and the Republican party.
US stocks rallied, while the dollar made a renewed attempt to recover from a 2½-year low in the belief that lower taxes would spur faster economic growth. In addition, bond yields jumped on concerns an unfunded tax plan could increase federal borrowing to finance a bigger government deficit.
The biggest commodities news this past month, however, has been the recovery in the energy sector. The disruptions caused by Hurricane Harvey in August helped boost especially Brent crude and fuel prices. The International Energy Agency provided additional and general support when it said that strong demand growth had led to second-quarter demand outstripping supply for the first time since 2014.
In China, iron ore and steel prices have come under pressure ahead of the Communist Party’s twice-in-a-decade congress on October 18. The Chinese government is likely to continue to step up its efforts to combat pollution. This could lead to further plant closures and production curbs during the most-polluting months from November to March. These developments have hurt iron ore particularly hard at a time when cargoes from the world’s biggest producers in Australia and Brazil have been rising.
The persistent divergence between platinum and palladium has resulted in palladium trading above platinum for the first time in 15 years. Ever since the Volkswagen diesel emissions scandal broke a couple of years ago, palladium, which is the preferred metal used in pollution control for gasoline engines, has continued to outshine platinum (preferred in diesel engines).
These developments have led to tight supply of palladium, while platinum is suffering from ample supply. Although platinum trades at a record discount to gold of more than $360, its positive correlation to gold remains higher than against palladium. So the short-term direction of gold holds the key to which of the platinum group metals will perform.
Gold has now retraced half of the $150 rally seen between July and early September. Corrections, as long they do not become too deep, are healthy as they provide an opportunity to get involved for others who missed the initial move.
Gold has, however, been trading sideways for the past four years, with the price averaging $1,235/oz during this time. With the latest developments, the chance of this range being broken any time soon has diminished once again. The early September rally fell short of challenging the 2016 high at $1,375/oz, and so we are seeing an increased risk of the market staying range-bound for longer.
In the short term, we need to establish whether the current weakness is more than a relatively deep correction. The positive technical outlook, albeit challenged, should remain as long gold holds above $1,260/oz, a level of significant technical importance.
The Weekly Petroleum Status Report from the US Energy Information Administration showed US crude oil exports jumped to a record, while surging imports of fuel together with increased refinery activity helped boost gasoline inventories. These two developments helped reduce WTI’s discount to Brent, with increased export of WTI crude oil supporting a reduction in the tightness seen in the Brent spot market this month.
Increased availability of gasoline saw refinery margins return to pre-Harvey levels, with tightness now only seen in middle distillates such as diesel. Lower refinery margins could ultimately mean lower demand for crude oil. Oil fundamentals continue to improve, with Q2 demand outstripping supply for the first time since 2014, according to the International Energy Agency. On that basis, a return to levels last seen during the unsuccessful attempt to rally during Q1 seems justified.
Record US exports — if maintained during the coming weeks together with Libya’s intent to boost production by 30% before year-end — risk putting some downward pressure on Brent relative to WTI. Brent has seen surging demand from funds and passive long-only investors after the return to an investor friendly backwardation.
In the week to September 19, funds held a net long of 465 million barrels in Brent crude oil, just 43 million below the February record. The failure to break higher back then eventually helped trigger a 13 per cent correction.
Given the improved outlook, we raise our Brent crude oil band by $5 to a range between $50/barrel and $60/b. In the short term, and baring any escalation in Northern Iraq, the performance this past week has increased the risk of a correction which potentially could see Brent reverse lower towards $54/b.