By Ole Hansen
The month of May went from bad to worse as the trade war rhetoric between the US and China moved up a notch. Commodities, dependent on growth and demand, took fright, with the energy sector leading the Bloomberg Commodity Index to a weekly loss.
The latest trade war escalation, triggered by the White House’s decision to blacklist Huawei and several Chinese surveillance companies, has further increased pressure on the global supply chain of goods and services. It has also raised the risk of a technology Cold War and helped send semiconductor equities into a tailspin.
The overall weakness in EM stocks, not least South Korea, given its importance as a gauge for activity in China, has further raised concerns that the current slowdown across the major economies is unlikely to be reversed anytime soon. The US is not immune, with Q2 growth heading towards 1%, while additional headwinds are being stirred up by the strong dollar, which this past week, according to one US Fed measure, reached its highest level since 2002.
Beyond the sharp fall in the energy sector, weather worries in the US continued to drive a reduction of what up until recently was a record short position held by funds across the key crops of corn, soybeans and wheat.
Industrial metals struggled amid the current growth worries with HG copper at one stage almost giving back the gains for the year. Precious metals meanwhile received a lukewarm bid despite support from falling stocks and lower bond yields. Gold’s inability to move higher despite an overwhelmingly supportive backdrop remains a puzzle at this stage.
Opposing forces had up until recently managed to keep crude oil stuck in a relatively tight range. Middle East tensions and the Opec+ group of producers maintaining and potentially extending current production cuts have supported the flat price of oil.
This despite concerns about slowing demand growth as the negative impact on the global economy of the US-China trade war continues to spread.
That was until this week when the latest escalation of the trade war triggered a rethink and fresh selling from macro-orientated funds worried that the outlook beyond the current tightness could begin to deteriorate. Adding to this is the dollar, which, according to the US Fed’s trade weighted broad dollar basket has reached its highest level in 17 years.
The trigger that pushed many long positions towards the exit and promoted a 6% two-day sell-off was a 16.8mn-barrel weekly increase in US crude oil and product stock to the highest total since October 2017. The tightness caused by dramatic Opec production cuts, however, has not gone away and this helps to explain why the flat price spread versus later traded futures month remains at its highest level in five years.
Regarding the recent escalation of tensions in the Middle East it is our belief that the risk of it leading to an armed conflict and a subsequent spike in crude oil prices is very unlikely.
With President Trump often measuring his success on low gasoline prices and high stock market valuations, a war with Iran does not make any political sense with an election to be fought in 2020.
However, with the global economy showing further signs of cooling as the impact of the US–China trade war begins to be felt outside of Asia, the risk is that slowing demand growth eventually will overtake the risk of lower supply.
The Paris-based OECD has downgraded further its projection for global growth this year while Eric S Rosengren, the Boston Fed president, warned that the trade war is increasing downside risks to the US economy.
While WTI crude oil led the weakness, the selling in Brent picked up following the break below key moving averages before finding support at $67/b and bouncing ahead of the long weekend that will see the US and UK markets shut on Monday, May 27.
Having rallied almost non-stop since late December it makes sense for the market to pause given the multiple opposing drivers currently in existence. Brent crude oil remains in an uptrend and this will only, from a technical perspective, be challenged on a break below $65.8/b.
Gold traded close to unchanged following another bout of long liquidation from funds having bought into the recent failed breakout attempt above $1,300/oz.
Stock market uncertainty and a renewed drop in bond yields provided some support but not enough to attract renewed investment demand from traders having seen the price whipsaw during the past few months.
The dollar remains a key drag with its continued strength against most of the major currencies, not least the Chinese renminbi where speculation is rife about whether the Peoples Bank of China will eventually allow it to weaken beyond $7.0.
While the US Fed has adopted a wait and see approach, the policymakers may be overtaken by current events, which is raising the risk of a bigger and sharper response in terms of cutting rates than what is currently expected.
On that basis, we are not ruling out a potential and surprise 50 bps rate cut before September, a move which could hurt the dollar while helping gold to break the current deadlock and move higher.
The correction from the February peak has lost momentum with a sideways trading pattern having taken over. A weekly close below $1,275/oz would increase the risk of a downside extension to $1,253/oz while a break above $1,303/oz is needed to attract renewed demand.
* Ole Hansen is head of commodity strategy at Saxo Bank.
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