Ole Hansen Head of Commodity Strategy / Saxo Bank
A tumbling Chinese yuan triggered a major rout across global markets during the first trading week of the year. Plunging Chinese stocks twice forced trading halts, while global stocks had the worst four-day start to a year since 1988. Oil prices collapsed to the lowest since 2004, gold surged on safe-haven demand and short-covering from overextended short positions, and industrial metals fell under the weight of potential bigger-than-expected slowdown in China, the world’s biggest consumer.
Looking at the individual commodity performances below, it felt a whole year was packed into just one week. The overriding theme which helped drive the Bloomberg commodity index to a 1999 low was the uncertainty about whether the accelerated devaluation of the yuan was an expression of unexpectedly sharp slowdown in China.
Stock markets across the world took fright at this thought, and China's Shanghai Shenzhen CSI 300 index slumped by double-digit percentages before managing to stabilise at the end of the week when the CNY finally fixed a bit higher. The stronger than expected US job report on Friday failed to trigger a recovery which indicates that more pain can be expected in the short term.
The energy sector was the hardest hit despite some support from colder US weather, which helped send natural gas higher. Crude oil traders started the week getting caught out by heightened geopolitical tensions between Iran and Saudi Arabia. But the price boost this uncertainty lent the market lasted less than 24 hours, and what followed was a sharp selloff.
This was driven by a resumed focus on the current global oversupply, which is only expected to get worse this quarter before improving later this year. Adding to the supply focus traders also had to deal with the potential impact of Chinese demand failing to meet expectations.
WTI and Brent crude found support at $32/barrel, while Opec's oil basket continued to slump reaching $27.85/b on Thursday. Spare a thought, however, for Canada where the price of the Western Canadian Select, one of the most expensive crude oils to extract, slumped below $20/b to hit a record low at $19/b. Current prices are well below shut-in levels, and we could start to see producers taking projects offline or shut down completely.
Lower prices are the cure for high production, and with increasing numbers of high-cost producers in the US and Canada now operating below the shut-in level, we will see output begin to slow over the coming weeks and months. But before that happens the market still have to deal with the extra barrels to come from Iran within weeks, while at the same time coping with US inventory levels, which are more than 100 million barrels above the five-year average. The important storage facility at Cushing, Oklahoma, which serves as the delivery hub for WTI crude oil futures has seen a 10-million-barrel increase during the past couple of months. At 63 million barrels, tanks are approaching full capacity, and if they fill up, tank owners will need to push oil away at lower prices to attract buyers.
The oil recovery, once it eventually occurs, will not happen until the market becomes convinced that the risk of further losses has been reduced. What will follow is a potential sharp move higher, with speculative shorts adding some additional upwards pressure.
Geopolitical risks are never far away, and the new year gave us a reminder of this, with the spat between Iran and Saudi Arabia. But it also gave a good indication of how immune the market has become as the sheer overhang of supply has reduced the threat of price spikes similar to those witnessed during earlier parts of this decade.
The geopolitical risk premium tends to be priced through Brent crude, so any increased tension could see Brent recover some of the premium against WTI crude that was lost following the removal of the US export ban last month.
In the near term, the $30/b level will provide a major line in the sand, while a breach of resistance at $40/b will be required before we can begin to talk about a low being in place. The options market has seen a major pick-up in demand for puts, with strikes at $30 and $25, and this could be an indication of increased fear of further losses or simply that traders increasingly prefer to express further price weakness through options.
Gold has started 2016 on the attack, with prices heading higher, particularly when priced in yuan. Safe-haven bids and lower bond yields related to the tensions in the Middle East, combined with the Chinese troubles and yuan devaluation, have all helped to attract buyers (not least from hedge funds who entered the year holding a record short position).
From a technical perspective, gold has been trading sideways since November, but the break above $1,102/oz has opened the door for move higher, initially to $1,119/oz. The stronger-than- expected US job report on Friday failed to send the dollar higher, and gold managed find support ahead of $1,088/oz, which is now the key level below which sentiment once again could sour.
Investors trading gold through exchange-traded products were net-sellers during the past couple of weeks, and only at the end of the week did we see a pick-up in demand. Total holdings at the beginning of this year are still hovering just above a six-year low.
Any change in sentiment at this stage will leave many – and particularly the aforementioned funds – underinvested, but at this stage no large-scale reduction or change in sentiment has been detected. This leaves the upside limited for now with strong US data still pointing towards an accelerated pace of US rate hikes.
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