By Ole Hansen
Oil traders are seeing the waters of the global crude trade calm somewhat on declining US production and international output freeze speculation.
The energy sector delivered its first weekly gain in four despite seeing natural gas slump to a new 17-year low. Crude oil moved higher supported by falling US production and continued discussion among producers to limit their output.
Gold traded sideways following weeks of frenzied buying which has triggered a change in sentiment. Recession worries and lower central bank rates have created a degree of positive momentum that has attracted a dramatic influx of funds towards gold holdings in exchange-traded products. The negative correlation to falling stock and oil prices remains a key feature of this trade and any change in sentiment there may for now curb the upside and trigger a period of consolidation.
Other metals struggled to keep up with gold with silver now trading at the cheapest relative level since the 2009 recession. Copper remains rangebound but showed teeth by managing to shrug off a new setback in Chinese stocks. The aforementioned gains in energy and soft commodities helped drive the Bloomberg Commodity Index higher for the first time in four weeks. The index has now climbed 5% from the multi-decade low that was reached in January.
Commodities thrive on the combination of physical demand from consumers and paper demand from investors. A continued improvement from here hinges on the questionable global economic outlook. This broad global softness, of course, has made inroads into China and the US, the world’s two biggest economies and the main drivers of demand for key commodities such as energy and industrial metals.
Overall, however, the relative calm witnessed so far this month could be the early signs of an emerging stability with most of the negative drivers such as fading demand and oversupply being priced in.
Soft commodities jumped with sugar leading the gains after the International Sugar Organisation increased the global deficit for the 2015-16 season. Adverse weather related to El Ninõ is the main driver behind this change as it creates challenging conditions among growers from Brazil to India and Thailand. Inclement weather in Africa also helped cocoa to its longest rally in three months while coffee upside risk is growing from the potential shortfall in production from Brazil and Vietnam.
Just as in 2015, gold has once again been a very strong performer at the beginning of a new year. Last year, the Swiss franc event and the introduction of the European Central Bank quantitative easing programme helped give the yellow metal a boost.
The rally seen so far this year has raised questions about this being another short-term development with gold soon losing its allure again. In our view, however, the current action in market is a sign of a real change in sentiment towards precious metals and its credentials as an alternative investment.
The macroeconomic drivers are all well-known with the dramatic change in the outlook for US interest rates and the slump in oil and global stocks triggering renewed demand for gold.
Many investors got burned during the final stages of the run-up to $1,920/oz in September 2011 but the changed outlook during the past seven weeks has persuaded both technical- and macro-driven investors to get back in.
The demand for gold has been strong enough that holdings during the past seven weeks have risen by almost the same amount that was withdrawn during 2015. February is currently on track to yield the biggest monthly increase in seven years. Money managers started the year with a record net-short and the short covering and rebuilding of longs that followed has also been an important driver.
During the week ending February 16, they had accumulated a gross long position of 13.5mn ounces which was 15% below the October peak and 30% below the January 2015 peak.
Gold has entered its recovery cycle but after already having reached a level few would have deemed possible so soon after the first US rate hike in nine years, some additional consolidation and testing of support may now be necessary before the rally resumes. Key support remains located between $1,190/oz and $1,170/oz while above the recent high at $1,263/oz, traders will be focusing on the 2015 peak just above $1,300/oz.
The dollar, stocks and oil (particularly given the latter’s sway on global equities) remain the three major drivers for gold during the coming weeks. Options traders favour calls over puts by the largest margin since October 2009 when gold was heading towards its peak. Such strong bullish sentiment will not go away overnight and on that basis we prefer buying on dips instead of trying to look for a near-term peak.
Crude oil continues to consolidate and Brent crude moved higher as the lack of surplus selling triggered short-covering ahead of Monday’s April futures expiry. This helped drive the discount between April and May futures down to less than $0.30 and Brent’s premium to WTI out to $2.5/b, the widest level seen since December.
Money managers betting on a recovery in oil prices have increasingly been focusing on Brent crude and this has resulted in the net-long rising to a near record of 285,000 lots. WTI crude, meanwhile, is faced with the highest inventories since 1930 and the prospect of these rising for at least another month. These developments have made it the most popular contract for sellers.
A stronger-than-expected US GDP print on Friday helped drive both WTI and Brent up to their key resistances at $34.80/barrel and $36.75/b respectively. A break above this level will bring $40/b oil back into focus.
With the global supply glut not expected to be removed before 2017, a major rally at this stage is not supported by fundamentals but with so much focus on oil on both the short and long trades, any break out of the prevailing range will trigger a reaction and a potential overshoot.
Ole Hansen is head of commodity strategy at Saxo Bank.
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