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USD retreat drives commodities index higher

September 2017

By Ole Hansen, Head of Commodity Strategy at Saxo Bank

September 10, 2017 | 13:45 | Dubai

The Bloomberg Commodity Index traded higher for a second week with general support coming from the accelerated dollar selloff. The greenback hit the lowest level seen since January 2015 against a broad basket of major currencies. Leading the way lower was another jump in the euro, which is now up 15% year-to-date against the dollar. This after the European Central Bank left out any notion of concern about the continued strength following its latest meeting.

The gains were spread out across several sectors including energy and grains. This follows a few weeks were gains primarily had been driven by metals, both precious and industrial. The latter traded lower for the first time in five weeks as the rally, which began almost three months ago, increasingly looked in need of a correction.

Crude oil recovered on a pickup in demand from refineries along the Texan Gulf coast. The impact of Hurricane Harvey on the US energy market became apparent in the weekly status report which highlighted the collapse in refinery demand, imports, and exports as well as production.

Cotton and Orange Juice rose strongly as hurricane Irma, the second potential catastrophic hurricane to hit the US within two weeks took aim at growing regions in Florida and beyond.

Gold’s rally extended further on continued support from a weaker dollar and bond yields as well as the raised market risks both from the hurricanes slamming into the US and continued tensions on the Korean peninsula.

Grain markets recovered as short positions were scaled back ahead of a monthly supply and demand report from the US Department of Agriculture on Tuesday September 12. Last month’s World Agriculture Supply and Demand report helped send grain futures lower as it increased yield and production by a larger margin than was expected.

HG copper reached a three-year high before running out of fresh buying. We view the metal as being increasingly detached from fundamentals with traders looking more at the bullish momentum than specific drivers to justify a 27% rally since the low point in May.

Bullish fund bets have reached a record high and in the process have dislocated from the otherwise decent correlation to China Manufacturing PMI. Chinese leading indicators (Nomura’s) have been pointing lower since April, during which time copper has rallied strongly.

HG copper: A bearish shooting star on the weekly chart has raised the risk of a correction, potentially towards $2.90/lb:

Source: Saxo Bank

Gold continued higher with increased demand for physical, futures, and exchange-traded products being driving by favourable technical, macroeconomic, and geopolitical developments. Most important has been the continued dollar weakness; given its strong inverse correlation to gold, USD’s year-to-date loss help explains more than half of gold’s 16% rally.

Adding to this we have the decline in government bond yields, which reduce the opportunity cost of holding a non-coupon or dividend-paying asset. After hitting a low point back in July, the amount of outstanding global debt with a negative yield has since jumped to the highest point since last November.

Increased safe-haven and diversification demand from real money investors looking for a hedge against rising geopolitical tensions and Trump’s inability to move forward have also been factors this year.

The biggest risk to golds further progress come from a potential de-escalation of the current tensions on the Korean peninsula and or increased verbal ECB intervention against the rising euro. These developments if seen could trigger profit-taking from funds that have been continued buyers for the past six weeks.

The 2016 rally was halted at $1,375/oz, just ahead of the first major retracement of the 2011-2015 selloff at $1,380/oz. This area will once again be the focus but also one that is likely to attract some profit taking similar to what we found at $1,300/oz on three occasions earlier this year.

We maintain our end-of-year call at $1325/oz although it is looking increasingly conservative at this stage. A break above $1,380/oz, however, would set the stage for a continuation towards $1,484/oz and that would be the signal for us to raise the forecast.

The Weekly Petroleum Status Report from the EIA covering the week to September 1 gave the first clear picture of the disruptions Hurricane Harvey inflicted on the US energy industry. As expected, the report showed rising crude stocks at the expense of fuel. This came in response to a steep decline in refinery demand.

Imports and exports also slumped but what surprised the most was a near 800,000 barrels/day reduction in crude oil production from offshore sites and particularly the Eagle Ford shale oil region.

The diverging performance between WTI and Brent crude that emerged ahead of Hurricane Harvey resumed this week. Brent crude has rallied further after breaking the downtrend from January only to find resistance ahead of a band of resistance above $55/barrel.

The widening of the spread between Brent and WTI beyond $5 has primarily occurred at the front of the curve. This has come in response to improved Brent fundamentals and a growing glut of WTI crude oil after Harvey knocked out refinery capacity along the Texan Gulf Coast.

Brent crude oil has benefited from a jump in refinery margins around the world in response to the disruptions seen in the US. This has triggered a return to backwardation at the front of the curve, with the prompt futures price trading higher than the following months.

WTI, on the other hand, has suffered from rising contango as the supply glut increased pressure on prompt prices.

Apart from the weaker dollar, the latest rally has been driven by short-covering in WTI and a short-term improvement in the fundamental outlook for Brent. The return of barrels from Libya after a week of local disruptions combined with the seasonal slowdown in demand normally witnessed at this time of year should continue to limit the upside for oil to $50/b on WTI – a level generally viewed as the breakeven for many US shale oil producers – and $55/b on Brent.

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