Ole Hansen –
Most major commodities managed to stabilise on Friday following a week of heavy selling. Steep losses were seen across the major sectors of energy together with industrial and precious metals. The Bloomberg Commodity index fell to a near six-month low with crude oil giving up all gains made since the November deal to cut production. Copper posted its biggest two-day loss since 2015 while gold was led lower by selling of silver and platinum.
China received a great deal of attention as industrial metals, including iron ore, were driven lower by demand concerns as China tightens credit further in its effort to cool speculation and excessive risk-taking.
With the cost of credit rising, the housing sector could be impacted just as the impact from the 2106 infrastructure spending spree begins to fade.
Oil, however, was where most of the week’s action occurred. Constant but controlled selling by disgruntled longs during the past couple of weeks turned into a rout once the March lows on WTI crude at $47/barrel and Brent crude at $50/b were broken.
The negative price action was further strengthened by increased short-selling from technical and momentum traders.
Beef prices surged on the risk of tightening supply following reports that thousands of animals in feedyards across the US Great Plains may have been killed following last weekend’s blizzard. The snowstorm also provided a boost to key crops on planting delays and concerns about the impact on winter wheat in the ground.
Crude oil has returned to pre-November cut levels following a two-day selloff that saw WTI hit $43.76/barrel during Asian hours on Friday. Funds holding elevated long bets had already begun scaling back longs during the past couple of weeks.
The loss of patience came in response to a continued flow of news about rising supply. The break below key support on Thursday triggered accelerated selling with new short sellers also weighing in.
There are multiple reasons behind the latest weakness:
n US oil production has risen by 840,000 barrels/day since the October low point and so far it is not showing any signs of slowing. Last week it reached 9.3 million b/d, the highest level seen since August 2015.
n US car sales dropped in April for a fourth month in a row raising concerns about gasoline demand into and during the peak demand season.
n China continues to tighten its monetary policy while the impact of the 2016 infrastructure spending surge begins to fade.
n Libya resumed production from its largest field last week leading to an output jump of more than 200,000 b/d to 760,000 b/d.
n Opec’s production cut efforts have been impacted by signs that shipments from producers are not slowing accordingly (an indication of some oil export coming from storage).
Hedge funds have been scaling back longs in both WTI and Brent crude oil for the past couple of weeks. That selling accelerated and was joined by new short-sellers once technical support at $47/b on WTI crude and $50/b on Brent crude gave way.
WTI crude oil found support after retracing 38.2 per cent of the 2016 to 2017 rally. An extension would bring $42/b, the November low, into focus ahead of the psychological level at $40/b.
The worst of the capitulation phase is potentially over as the markets show signs of stabilising but we see limited upside until hard data turn more favourable towards H2.
Having entered into a capitulation phase, it is not the price but the size of the positions held by those needing to reduce that will determine where we go from here.
However, two high-volume days are likely to have created a better balance between long and short positions and we can expect verbal intervention to be stepped up. The Opec meeting on May 25 is also eventually going to attract some opportunistic buying as consensus to maintain cuts begin to emerge, but at this stage a break back above the March low will be needed in order for calmer market conditions to return.
The rapid rise (until now) in US crude oil production could be called into question as the price of WTI crude oil returns to the mid-40s. Some shale oil producers may begin to struggle at these levels, but overall the impact may be limited.
(This considering the aggressive hedging of 2017 and even 2018 production seen during Q1 when the price surged on Opec cut optimism.)
Gold traded lower for a third week. It was pulled lower by silver and platinum as they reacted negatively to the China demand story. In addition the Federal Open Market Committee meeting on May 3 left the door wide open for a June 14 rate hike, something the April US job report supported, while safe-haven demand further deflated ahead of the deciding final round of the French presidential election. The US job report for May only strengthened the belief that the FOMC will hike rates in June.
Hedge funds have actively been buying gold for the past six weeks with the net-long in Comex gold futures more than tripling during this time. This left gold exposed to long-liquidation once the 200-day moving average was broken at $1253/oz.
From a technical perspective the March to April uptrend is in trouble following the break below trend-line support and the 61.8 per cent retracement. A break back above $1250/oz will be needed to reduce the risk of an extension towards $1295/oz, the March low.
Changes in gold holdings in exchange-traded products did not surge to the same extent as the recent surge in futures longs, and during the recent selloff there have been limited signs of long liquidation. This leads us to believe that the weakness at this stage is nothing more than another correction following a period of strong speculative buying.
A move higher in both US real yields and USDJPY provided the fundamental reason behind the recent selling and these two components remain a key driver for gold.
Silver’s weakness relative to gold reached an 11-month high as the gold-silver ratio touched 75 (ounces of silver to buy one ounce of gold). Likewise, demand for platinum was hit by the continued slowdown in car sales and against gold it reached the second widest discount on record at $340 before recovering to $318.
Once the market stabilises, these two metals may attract some attention from a relative value perspective.
[Ole Hansen is head of commodity strategy at Saxo Bank]