Gold and oil looking for a floor while gas spikes

The commodity sector remains on the defensive with rising supply hurting a diversified group of raw materials from crude oil to grains. Growth concerns in the world’s two biggest economies into 2019 put industrial and semi-precious metals under pressure while gold struggled to build on the recent recovery amid a strong dollar with a hawkish Federal Open Market Committee staying on course to hike rates further over the coming months.
The US midterm election yielded no major surprises with the Democrats, while taking control of the House, failing to create a ‘Blue Wave’. The Republicans did not see a ‘Red Repeat’ but still managed to strengthen their Senate majority. A relief rally was seen in stocks, bond yields resumed their climb while the dollar, after some initial weakness, strengthened once the Federal Reserve indicated it would keep raising rates gradually over the coming months.
The initial impact of the election on commodities has been limited but over time we may keep an eye on things like late-cycle US economic growth not receiving a further boost through tax cuts, unfunded infrastructure spending impacting industrial metals, budget deficit and bond yields, opposition against Trump’s deregulatory energy agenda could impact the long-term prospect for US oil production growth, a divided US government potentially weakening the dollar over time.
The biggest headline grabber was crude oil, which continued its slump as Iran sanctions worries faded and the world’s biggest producers continued to ramp up production. Overall the energy sector was close to flat on the week with the strongest natural gas surge in two years helping to offset the weakness in crude oil and products.
Natural gas is up by more than 10 per cent on the week as a cold blast across the eastern part of the US has increased the focus on stock levels which will enter the winter peak demand period at a 15-year seasonal low.
In just six weeks market speculation has seen a dramatic turnaround from focusing on Brent oil at $90 per barrel before yearend to the current speculation of $60 per barrel. West Texas Intermediate (WTI) crude oil was the biggest loser of the two crude oil benchmarks as surging US production and rising stocks and lower refinery demand, due to maintenance, saw the price slump by more than 22 per cent from the October peak and thereby returning to bear market territory.
Gold is currently stuck in a range between $1,210 per ounce and $1,240 per ounce with the October recovery primarily driven by short-covering from hedge funds. Back then they found themselves holding a record and, in the end, unsustainable short position amid emerging signs of safe-haven and diversification demand as the stock market rout unfolded and bond yields jumped.
Following a 55 per cent reduction during the past three weeks the tailwind from buyers covering bearish bets has now faded. With risk appetite for stocks and the dollar returning together with the Federal Reserve continuing to hike rates, the bears at this stage are once again looking to take control. Not helping the sentiment has been and even bigger sell-off in silver, which remains troubled by its link to under-pressure industrial metals.
In the belief that the stock market recovery is on its last leg and that a strong dollar remains unsustainable we maintain the view that investors will continue to look for alternative investments. This will be done both as a hedge against the risk of inflation and an emerging positive correlation between stocks and bonds.
Gold is currently trading within a 31-dollar range. A break below $1,201 per ounce and more importantly $1,191 per ounce would see the bears back in charge. Potential buyers, meanwhile, are likely to sit on the fence and wait for a break above $1,243 per ounce, a move that would force renewed fund short-covering.
Crude oil overwhelmed by supply
The rout in crude oil extended into a fifth week driven by the themes of rising supply from the world’s three biggest producers, the US, Russia and Saudi Arabia, together with rising US stocks. WTI crude oil entered bear market territory after slumping by more than 22 per cent while Brent crude broke below the psychologically important $70 per barrel level.
This was otherwise the week when the US re-introduced sanctions against Iran, an event that back in early October helped drive Brent crude above $87 per barrel on worries that the global market would be left shorthanded. In order to provide other producers enough time to increase production, the US administration chose to grant waivers to eight countries to carry on buying Iranian crude for up to six months.
Adding to the weakness this week was the US Energy Information Administration which in its Short Term Energy Outlook for November raised its US crude output forecast for 2019 by 0.3 million barrels per day to a record 12.06m barrel per day while cutting global demand growth by 0.1m to 1.4m. However, the EIA also said that global refinery demand, estimated to be lower by 2 million barrels per day due to maintenance, would begin to pick up and return to normal during the coming weeks.
Having responded to Trump’s request for additional barrels to prevent the price from spiking, the subsequent 17-dollar sell-off since early October has now instead increased the likelihood of production being scaled back to support the price. The Joint Opec/non-Opec Ministerial Monitoring Committee meeting in Abu Dhabi on November 10-11 could now, according to delegates, include a discussion about cutting supplies into 2019. This occurs with the realisation that US sanctions against Iran may not yield as big a drop as feared, while US production continues to ramp higher and the growth outlook for 2019 is being called into question.
We maintain the view that crude oil eventually will settle into a $70 to $80 per barrel range. Opec and Russia may use cuts to support $70 per barrel while the US administration could potentially use some flexibility on its waivers to prevent the price from breaking above $80 per barrel.
In the shortterm, however, the risk is one of the market overshooting to the downside. When it traded above $80 per barrel the market was calling for $90 per barrel and below $70 per barrel the talk will now be about $60 per barrel next. Neither of these are sustainable but they still create the volatility that we have grown used to in the oil market.
For the oil market to stabilise, selling from hedge funds first needs to be reversed. Judging from the pace of selling during the five-week period to October 30, this may require more than verbal intervention from Opec. However, having cut bullish bets in WTI and Brent crude oil to 13- and 15-month lows respectively, it would almost take a fundamental shift in the market outlook for this to deteriorate further.