Heightened geopolitical risks last week triggered by sharp rhetoric between US President Donald Trump and North Korea boosted demand for gold, the Japanese yen and secure bonds, while high-yielding bonds and stocks were sold off. Precious metals and surprisingly also industrial metals gained, energy commodities were flat, while agricultural commodities slumped.
Precious metals led by gold and silver continued the month long recovery as market developments created multiple tailwinds. The biggest one-day loss in the S&P 500 since May added additional demand from investors seeking shelter from a potential oncoming storm.
Industrial metals surged, with the Bloomberg Industrial Metal Index reaching a 30-month high and overbought territory before being hit by profit-taking as tensions escalated and oil prices weakened. Speculative demand from China, especially for steel and iron ore, added to the initial rally.
The energy sector was mixed, with natural gas rallying the most in eight months as inventories moved closer to the longer-term average and on news that the US was moving towards becoming a net-exporter of natural gas. Crude oil fundamentals show signs of improving, but overall the price remains torn between rising production and falling inventories.
A shocker of a misread on the outlook for US and global stocks of key crops left funds reeling from too much exposure. The World Agricultural Supply and Demand Estimates (WASDE) report for August helped send the sector sharply lower, with the Bloomberg Grain index almost hitting historic lows and wiping out the final part of the strong gains seen in early July.
Gold continued its ascent towards key resistance as stronger-than-expected US economic data focus was replaced by safe-haven demand. Profit-taking following the early August US nonfarm payrolls report proved short-lived.
The month-long rally resumed after President Trump’s “fire and fury” warning to North Korea. It created multiple tailwinds for gold as stocks and bond yields dropped, while the JPY rallied.
Hedge funds have, as usual, provided most of the ammunition when it comes to market volatility. The most recent failed selling cycle last month took the net long position in futures and options down to just 2.9 million ounces, an 18-month low. Since then a record 9.4 million ounces has been bought. From a recent historic perspective, positioning was relatively light, with the net long of 12.3 million ounces — recorded on August 1 — being below the 17.5 million seen during the most recent attempt to break above $1,295/oz and some 43 per cent below the record from June 2016.
Persistent worries about North Korea are likely to keep selling appetite muted, and the tension has opened up for another test of key resistance at $1,295/oz. A break above could see the market extend further as macro and directional funds would increase exposure, not least considering the above-mentioned light exposure compared with last time this level was challenged.
The binary nature of the Korean crisis could either trigger a break above $1,295/oz and an extension towards $1,375/oz, the high from last June, while a potential easing of the tensions carries the risk of profit-taking, with $1,250/oz providing support ahead of $1,230/oz, the 200-day moving average.
Crude oil has settled into a relatively tight range after surging in July. The rally last month was driven by short-covering as the Saudis cut exports and US inventories declined further. The upside, however, remains capped as rising production in the US and Libya are likely to offset these continued inventory and export declines.
Lower compliance and a strong pick-up in Libyan production were the two drivers that sparked this year’s third short-selling cycle back in June. During that month, the gross short position held by hedge funds in Brent and WTI crude oil hit the second highest on record. Come July and the above-mentioned export cut and falling inventories left the market vulnerable to short-covering, and a short squeeze followed.
During the five-week period to August 1, hedge funds increased the combined net long in Brent and WTI crude oil by 294 million barrels. Fresh buying added 102 million barrels, while the short position was cut in half by 192 million barrels. Last week’s 101-million-barrel net increase was the biggest weekly
addition since early December when Opec and Non-Opec producers announced their joint initiative to curb production.
Having seen WTI return to $50/barrel and Brent getting close to our third-quarter target of $55/b, it is worth once again taking a look at what is required to maintain the recent recovery in oil:
– Slowing US rigs and production growth in response to lower prices
– Strong seasonal reduction in US crude oil stocks (season normally runs till end-September)
– Opec reins in cheaters, especially Iraq and UAE, while reducing visible exports (ex USA)
– Slowdown in or renewed disruptions to production growth from Libya and Nigeria
– Geopolitical event
Overall fundamentals continue to improve, with US and global inventories now falling in response to stronger-than-expected global demand growth. The front end of the Brent curve has moved into backwardation as the prompt price trades higher than the next month. While sending a signal that inventories are being reduced (on peak summer demand), it has also helped increased Brent’s premium over WTI. Something that could increase export demand for US crude, thereby further reducing US inventories.
The IEA also cut its estimates for crude oil needed from Opec in both 2017 and 2018. This is a development which will make it increasingly difficult for Opec to increase production once the current agreement expires next March.
While bulls are building a long position (again), the market is still likely to remain range-bound and in essence lower for longer, relative to the price levels seen at the beginning of the year. Alternating focus between rising production and falling inventories could see WTI maintain a short-term trading range between $47 and $50.5/b.
— By Ole Hansen – Head of commodity strategy at Saxo Bank