Same old song? Oil traders await the outcome of Opec’s next Vienna meeting,
but the questions surrounding the much-awaited production deal are hardly binary.
Photo: Johann Strauss monument, Stadtpark Wien, iStock

Global financial markets continue to reset and adjust expectations following the US elections. The belief that US will lead a growth charge through raising fiscal spending instead of central bank quantitative easing and austerity has triggered a major response from all asset classes with the dollar, stocks, and bond yields all moving higher.

A stronger dollar tends to have a negative impact on the commodity sector as a whole. However, expectations for increased infrastructure spending (and not only in China) and an Opec deal on November 30 have so far provided support to both industrial metals and the energy sector.

Precious metals have been the biggest loser with the stronger dollar, stocks, and bond yields all helping to reduce the appetite for gold and silver as an alternative, safe-haven investment. ETF holdings have seen their biggest four week reduction since July 2013 and the price of gold has reached levels where the future of the near-one year uptrend has been called into question.

The agriculture sector has performed reasonably well with the exception of sugar and coffee, where the weaker Brazilian real has triggered a reduction of overextended speculative long positions in both.

The notoriously volatile natural gas contract has recovered strongly on the outlook for a colder-than-normal US winter and an earlier-than-expected first seasonal drop in stateside stockpiles.

Gold and particularly silver remain troubled by the current focus on the dollar, stocks, and bond yields rally. The resilience seen among longer-term investors using exchange-traded products has started to fade with reductions seen continuously since November 9.

Options traders are the most bearish on gold since August last year when US rate hike speculation began to intensify. The one-month risk reversal with a 25% delta has moved from favouring calls by more than 3% just before the US presidential election to favouring puts by around 2.9% now.

With some of the gold weakness deriving from the stronger dollar, it is worth taking a look at gold priced in other currencies. China and India, for instance – the world’s two biggest buyers of physical gold – have both seen their respective currencies weaken during the past couple of weeks.

While XAUUSD is down 6.8% since the day of the US election, XAUINR is down by 3.7% and XAUCNH has lost 4.7%.

Traders having opted to express a bullish gold view against the euro would have lost 3% while those speculating against the Japanese yen would have seen a small positive return.

Source: Bloomberg

Investors using exchange-traded products backed by gold have begun to wobble with total holdings falling continuously since November 8. The near-100 tonne reduction seen since the election was the largest since July 2013.

With the potential of between 100 and 200 tonnes of gold having been bought above current levels, the risk of further long liquidation remains high.

Heading into 2017 we are still not convinced that yields and the dollar will move much higher beyond January. If that turns out to be the case and inflation continues to rise, we could see support for both metals reestablished.

In the short term, attention turns to the Italian referendum on December 4 where a likely rejection could throw Italy into new political disarray followed by the US Federal Open Market Committee meeting on December 14 where a rate hike is now fully priced in.

Gold hit a key technical level at $1,172/oz on Friday and bounced higher. This was the 61.8% retracement of the December-to-July rally and is important in determining whether the week long selloff is a “just” a deep correction or an end to the uptrend.

A move back above $1,203/oz is likely to signal a period of consolidation while breaking $1,172/oz could open us up for more weakness.

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Source: Saxo Bank

Industrial metals and especially copper rallied strongly this November after trading sideways for more than one year. Expectations for robust Chinese demand (and now US demand, given Trump’s election pledges) have seen the metal diverge more than 30% against gold during the past month.

As a result, we have seen the gold-to-copper ratio (the number of pounds of copper it costs to buy an ounce of gold) fall to a 16-month low. A non-scientific approach says that a downward-trending ratio occurs when investors are betting on growing global economic activity.

When the ratio is rising, investors are more concerned about protecting their wealth in a slowing economic environment.

The ratio is testing trendline support from 2006 and an overbought (copper) versus oversold (gold) condition could see both metals consolidate and retrace some of their recent moves.

Crude oil was lower on Friday ahead of the “D-day” for the oil market on November 30 when Opec meets in Vienna to deliver an expected production cut.

The oil market has been gearing up to this day since late September when, amid rising supply and falling prices, the cartel meeting in Algiers promised to work towards a deal which would cap Opec production at between 32.5 and 33 million barrels/day.

In our opinion, Opec will cut production (it has to), but by how much and by whom are the questions which have kept the market rangebound for months now. A deal has yet to be struck with Iran being the missing link in an agreement that could see production slashed by up to 1.5 million barrels/day.

A successful solution is likely to see oil move above $50/barrel while a weak deal could see oil return below $45/b. This binary outcome is now likely to keep the market relatively quiet ahead of meeting on Wednesday.

During the past seven months the oil market has tried, often in vain, to guess what Opec was going to do next. During this time, price weakness was met by verbal intervention from producers while strength saw intervention fade while attention turned to the price-negative prospect of rising production from non-Opec producers, not least in North America.

While we expect Opec will deliver a cut, the question remains how united the cartel will be when presenting such a deal. A strong deal which would mean an across the board cut by 4.5% to around 32.5 million b/d with only Libya and Nigeria being exempt could see Brent crude make a return towards the October high just below $54/b.

The initial rally will be driven by short-covering with Brent having seen a rising speculative short base during November in response to an oversupplied market.

We doubt, however, that a deal at this stage will be enough to see the market make a range shift to the upside. Complying to agreed production limits has historical been a major challenge for Opec and the market is likely, once the initial rally has run its course, to adopt a wait-and-see approach while we wait for signs that the agreed cuts are being implemented.

Getting Russia and other non-Opec producers to commit to another 0,5 million barrels/day reduction could potentially change this outlook and help create a $50 floor as the market would then return to balance sooner than otherwise expected.

Brent crude oil has remain rangebound for the past seven months and have so far met strong resistance at $54/b:

Source: Saxo Bank


Ole Hansen
Head of Commodity Strategy / Saxo Bank