Commodity markets’ main source of influence continues to be the news flow related to the Covid-19 virus and the potential risk of it spreading further across Asia and beyond. China, already reeling from the economic and human impact, is struggling to return to work. The tentative recovery in key commodities such as copper and crude oil during the past couple of weeks was amongst other things driven by the narrative that the economic impact would primarily be a Q1 event.
With the virus continuing to spread outside of China, this narrative has given way to renewed concerns of the virus having a prolonged and negative impact on the global economy.
Goldman estimates that missed work days in China may be equal to the entire US work force taking a two-month unplanned break. The sheer size of this disruption is starting to be felt not only in China but also elsewhere, raising the risk of further short to medium-term pressure on growth-dependent commodities before demand eventually returns to boost prices.
It is clear that markets dependent on Chinese demand have suffered the biggest setbacks. Those with tight supply chains such as palladium and cocoa have been shielded from the storm while safe-haven demand has continued to drive strong demand for silver and especially gold.
Gold’s near perfect storm of price supporting developments continues. Most significantly, this past couple of weeks has shown the yellow metal’s ability to reach higher ground while the dollar strengthens. The normal negative correlation has broken down and this has led to some significant gains against most major currencies. Recently record highs have been seen against 10 out of 16 major currencies with gold priced in dollars still the one furthest away from hitting its $1921/oz record from 2011.
Gold continues its impressive rally this past week as it reached a fresh 7-year high following the biggest weekly gain in more than six months. As already mentioned, the recent extension has been particularly impressive at a time when the dollar has been breaking higher against several major currencies. The dollar strength has been particularly noticeable against the euro, which has dropped to a near 3-year low and in the process, gold priced in euros has rallied to a fresh record high above €1500/oz., thereby reaching another milestone for a rally that began just above €1000/oz in late 2018.
So why is gold in demand when US stocks continue to toy with record highs and the dollar keeps rising? We believe that the combination of additional rate cuts, increased stimulus, negative US real yields – which reached a 7-year low at -0.15 per cent – and increased worries about company earnings going forward will continue to drive strategic diversification and safe haven demand. Adding to this is the clear risk that the virus outbreak may have a longer and more profound impact.
January was a particularly worrying month for markets with US-Iran tensions being followed by the virus outbreak. During January, total holdings in ETFs backed by bullion rose by an average of 1.3 tonnes/day. So far this February holdings have, despite the mentioned dollar strength and recovering stock markets, been rising by 1.9 tonnes/day.
While Goldman sees gold heading towards $1,750/oz, Citi has said it could reach $2,000/oz within the next 12 to 24 months. Having reached our 2020 target of $1625/oz, the virus outbreak is likely to send it higher as it is difficult to see what at this stage can halt or pause the rally perhaps apart from its own success, which has led to a short-term overbought market condition.
From a technical perspective, using a Fibonacci extension, the next target is $1,690/oz with support at $1,595/oz.
In our latest Commodity Weekly we said that commodities offer a better insight than stocks when it comes to the real impact of the virus outbreak. Not least considering that the epicentre is in China, the world’s most dominant consumer of raw materials. On that basis, we remain concerned that the full impact on other markets from the slowdown in China and abroad is not being properly priced in.
The stock market has recovered strongly as investors have become increasingly immune to the apparent risks. Instead, focusing on the support coming from low inflation, low interest rates and central banks, led by the US Federal Reserve, continuing to pump liquidity into the market.
Copper and crude oil did provide some relief during the past couple of weeks after both managed to recover some of the steep losses seen during January.
Crude oil found some additional support from worsening supply disruption in Libya, US sanctions against Rosneft over its support for Venezuela and not least hopes for additional OPEC+ production cuts. Copper meanwhile responded positively to efforts made by the People’s Bank of China to support the economy through rate cuts and additional liquidity.
So far, however, from a technical perspective, the recovery in both commodities has been relatively small. Both have struggled to reach a 38.2 per cent retracement of the recent sell-off. On that basis we see the short-term risks once again being skewed to the downside.
This is in response to the renewed concern that the continued spreading of the virus will overshadow hopes that China’s stimulus efforts will cushion the blow to the biggest demand shock since the global financial crisis in 2009.
(Ole Hansen, Head of Commodity Strategy at Saxo Bank)