Commodities in broad-based retreat into year end

The Bloomberg Commodity Index slumped by the most since March this week as selling hit all sectors, particularly the twin bellwethers of energy and industrial metals. Only three out of 30 commodities tracked in the table below managed a positive return.
The agriculture sub-index fared even worse, as it dropped to levels last seen during the Great Financial Crisis nine years ago.
The combination of a stronger dollar and end-of-year position squaring probably added some additional pressure to the sector, not least among those individual commodities which have seen elevated speculative positioning up until now.
Despite an end-of-week recovery, crude oil is still headed for its second weekly loss with focus switching from a fully priced-in Opec production cut extension to US stocks, production and rig count.
A pick-up in Chinese imports last month helped support the market ahead of the weekend. Natural gas saw a fresh wave of long capitulation selling as the US winter continued to delay its arrival.
In metals, gold, silver and platinum broke key levels of support as the dollar rose in response to the increased likelihood of a US tax deal being passed and ahead of next week’s near-certain Federal Open Market Committee rate hike. The selling was particularly intense in silver and platinum.
Industrial metals suffered their worst weekly setback since March with aluminium and nickel enduring particularly steep reversals. On top of this, copper suffered its biggest one-day selloff in more than two years with the combination of a stronger dollar, end-of-year position squaring, and worries over the demand impact from China’s switch to a new and less metal commodity-intensive economic path.
The table below shows how the recent selling has begun tipping a few commodities into oversold territory. This is particularly true of precious metals led by silver and the soft commodities group (with the exception of cotton).
Gold traded lower after breaking its 200-day moving average and trendline support from the December low at $1267/oz. Speculators, having positioned themselves for a break above $1300/oz, got wrong-footed on a combination of a US tax deal moving closer and the stronger dollar. The weakness and long liquidation that followed was led by silver which already began its decline a couple of weeks back when it broke below $17/oz.
Silver tends to be a popular metal for traders due to its relatively high volatility. It has, however, been struggling all year to make an impression. While industrial metals rallied earlier in the year it held steady against gold and just recently when these metals started to correct silver quickly joined in by weakening against gold. The fading interest could be a sign that traders in search of volatility have moved to Bitcoin or other crypto currencies instead. It also highlights that gold’s primary source of support all year, apart from dollar weakness during the first half, has come from real money investors seeking tail-end protection against market risks elsewhere.
For the past four years gold has been averaging $1240/oz, a level it returned to this week following the break below technical support. From a technical perspective, the next major level of support can be found at $1200/oz.
However, during the recent weakness open interest on the Comex gold future has fallen to a four-month low. This indicates that while long positions have been reduced there has been no appetite for adding new short positions in the market. We see this as a sign of traders looking for a bottom to reinstate longs instead of adding fresh short positions in the belief the market will go much lower.
Despite an end of week recovery some buying fatigue started to emerge in crude oil following the recent successful delivery by Opec and Russia of a nine-month production cut extension. This, it could be argued, is a natural consequence of the fact that the decision was already being priced in ahead of the meeting and considering how far crude oil had rallied in the weeks leading up to the meeting.
The combination of oil market volatility having fallen to a three-year low and record long positions being held by hedge funds into the low liquidity weeks around Christmas and the New Year could still cause some major moves. With traders normally more focused on bringing down exposure than on adding it, we believe the market risk could be skewed to the downside during this period of time.
Following the Opec/non-Opec production cut extension, the market’s focus will increasingly be turning towards the US to see whether shale oil producers will be able to increase production in line with expectations.
Apart from the “Weekly Petroleum Status Report” from the US Energy Information Administration which takes a look at stocks, production and trade, the weekly rig count will also be watched closely in order to gauge the trajectory of US oil production. US oil production has in response to rising crude oil prices and apart from hurricane disruptions in September and October been rising steadily during the past 13 months. Last week it hit a fresh record of 9.7 million barrels/day.
Monthly oil markets reports from Opec and the International Energy Agency will be published on December 13. The market will be looking for signs of whether the wide diversion in demand and supply forecasts between the two will narrow. In the November update, Opec was looking for a 2018 deficit of 630,000 barrels/day while the IEA saw a surplus 100,000 barrels/day. Whichever way the pendulum eventually swings will have a significant impact on market sentiment.
Having broken the steep uptrend from October when supplies from Northern Iraq were disrupted, WTI crude oil shows signs of settling into a range with $55/b offering support and with resistance being $60/b, a level around which several failed attempts to break through were made during Q2 of 2015. Barring any new supply disruptions or geopolitical event, we maintain the view that the risk is skewed to the downside with consolidation being the most the bulls can expect at this stage.

Ole Hansen

(Ole Hansen is head of commodity strategy at Saxo Bank)