The energy sector traded flat when a spike in gasoline prices on hurricane Harvey fears helped offset small losses in crude oil. Precious metals traded quietly with gold struggling to break key resistance while waiting for news from the annual gathering of central bankers at Jackson Hole in Wyoming.
Most of the action, however, once again occurred in industrial metals. The Bloomberg Industrial metal index, led by zinc and aluminium, touched the highest since December 2014 and has now risen in eight of the past 10 weeks.
Gasoline prices surged as Gulf coast refineries began halting operations ahead of Hurricane Harvey’s expected arrival late on Friday. The first hurricane to hit the Texas coast in a decade could dump up towards one metre of rain in the most exposed areas, and this scenario boosted the price of soybeans and cotton on heightened crop concerns.
Sugar recovered as a near-record fund short was scaled back in response to news that the Brazilian government would impose a 20 per cent tax on ethanol imports that exceed the annual quota. This would support the domestic production of ethanol, thereby diverting sugar cane away from the production of sweetener.
December futures in CBOT corn and especially wheat both reached life-of-contract lows before bargain-hunting supported a recovery from oversold conditions. Wheat’s premium over corn recovered after collapsing during the rout this past month.
The rally in industrial metals, which has extended further, has China written all over it. China’s quest to close high-polluting smelter plants to reduce air pollution has been the trigger for the month-long surge in metals, not least aluminium and zinc. The combination of supply being cut and demand holding up has helped ignite a speculative surge in trading at futures exchanges in China and around the world.
Speculative trading in China is rife, and once again regulators has been forced to step in and introduce measures, such as reduced position limits and higher margins, to crack down on speculative dealing while urging investors to be cautious and behave rationally.
Copper enjoyed the tailwind from the rally, and reached a near two-year high on exchanges in New York and London. Funds speculating in higher prices on high-grade copper now hold the biggest exposure since records began in 2006.
Rising production and falling inventories has kept WTI crude oil hovering around $48.50/barrel for the past month. So far this August the trading range has narrowed to between $48.50/b to the upside and the 50-day moving average to the downside, currently at $46.70/b.
As we approach September the risk/reward however looks increasingly skewed to the downside. A break to the upside could see the market revisit $50/b, which would trigger increased hedging activity from US producers, while a downside break risks triggering a fourth wave of selling from funds holding the biggest combined net long in Brent and WTI crude oil since March 14.
Seasonal behaviour also has to be considered, with a market peak normally seen during the first week of September before the market enters the low-demand season.
The biggest risk to this assumption is the deteriorating outlook for Venezuela and the introduction of US sanctions designed to punish the government as President Nicolás Maduro continues to undermine the Venezuelan people’s right to self-determination. Any action that further reduces Venezuela’s ability to export its crude could provide some short-term support.
Gold spent a quiet but nervous week trading within a relative tight range between $1,280/oz and $1,295/oz. The failure so far to make a sustained break above the high of the year has left hedge funds and traders concerned that a correction might follow next.
So far, however, the market has held up with support — almost as usual — being provided by statements and comments by the US president. Trump’s threat to close down the government unless funds are found to build a border wall against Mexico helped prevent stocks and the dollar from recovering.
Speeches on Friday from Fed Chief Janet Yellen and European Central Bank President Mario Draghi at the Fed’s annual gathering of central bankers at Jackson Hole, Wyoming also helped keep gold range-bound, as the market awaited clues on the pace of monetary tightening in the US and Eurozone.
The technical outlook for gold remains pretty clear. A sustained break above $1,295/oz on spot is likely to propel it higher, while a break below the uptrend since July carries the risk of once again seeing longs being cut and the price suffering accordingly.
The market has held up well this past week despite the failure to break higher, which indicates that investors continue to look for diversification and in some cases a safe haven amid uncertainty about the direction of other asset classes, most noticeably stocks. One of the biggest risk to gold’s upside potential comes from an elevated and increasingly stale euro long position against the dollar. Any reduction in these bets could send the dollar higher and, with that, precious metals lower.
A move above $1,295/oz could see gold target the US post-election high of $1,337/oz. Below $1,280/oz technical retracement levels would point to $1,264/oz followed by $1,253/oz.
[Ole Hansen is head of commodity strategy at Saxo Bank]