Oil weighed down by demand concerns despite Middle East tensions

Ole Hansen joined Saxo Bank in 2008 and has been head of commodity strategy since 2010. He focuses on delivering strategies and analyses of the global commodity markets defined by fundamentals, market sentiment and technical developments. He is the author of the bank's Weekly Commodity Update, which sets out moves in commodities, and also provides clients with commodity-related trade views under the #SaxoStrats brand.

Website: https://www.home.saxo/en-mena/insights/news-and-research

Traders seem more concerned about lack of future demand than they do about potential disruptions to supply

An oil tanker is seen after it was attacked at the Gulf of Oman, in waters between Gulf Arab states and Iran, June 13, 2019. ISNA/Handout via REUTERS

An oil tanker is seen after it was attacked at the Gulf of Oman, in waters between Gulf Arab states and Iran, June 13, 2019. ISNA/Handout via REUTERS

Last week, the Bloomberg Commodity Index traded higher for the first time in four weeks. While growth-dependent commodities such as crude oil moved lower despite renewed concerns about stability in the Middle East, it was once again the agricultural sector that led from the front.

The metals sector saw gold trade higher to challenge key resistance while strike threats to supply saw palladium surge higher to record its biggest weekly gain in almost a year.

The BCOM Agriculture Index, which reached a record low less than five weeks ago, has since rallied by more than 22 percent to a six-month high. The 5 percent-plus return last week was primarily driven by the three key crops of corn, wheat and soybeans. Months of rains and floods delayed or even cancelled planting across US growing areas and these developments drove one of the most spectacular short-covering rallies on record.

The monthly supply and demand report from the United States Department of Agriculture confirmed the impact this past week with corn leading the charge higher following a larger-than-expected downgrade to production and stocks. Adding insult to injury, renewed forecasts for rain next week across the Midwest has further dampened hopes that unplanted fields can be sown in time.

Crude oil experienced a tug-of-war week with Mideast tensions only partly offsetting continued worries about global demand and rising US stocks. With no end in sight for a solution to the US-China trade war, the global growth implications continue to negatively impact the outlook for crude oil, which hit a four-month low last week.

The failure to build a geopolitical risk premium following the tanker attacks in the Gulf of Oman could indicate that the market is either sceptical of the narrative with regards to who did it, or that demand worries simply weigh too heavily at this stage.

The monthly oil market reports from the Energy Information Administration, Opec and the International Energy Agency all showed another downgrade to world oil demand while non-Opec supply growth was kept stable at almost one million barrels per day above demand. The IEA said that non-Opec supply would, barring any geopolitical shock, “swamp” the market in 2020, thereby leaving no room for Opec to reclaim lost market share.

Keeping both this and the Iranian tensions in mind, the upcoming Opec and Opec-plus meetings, scheduled but not yet confirmed for late June, are likely to be challenging. Saudi efforts to keep Russia on board with production cuts beyond the second half, let alone 2020, could easily become an issue.

Another significant challenge to the oil market during the past four weeks has been a continued rise in U.S. crude oil stocks. Record levels of production combined with weaker than normal refinery demand has driven an unusual counter-seasonal increase in crude oil stocks to a near two-year high. The combined daily price drop on the day of release during these past four weeks has been more than $8 per barrel, as highlighted by the arrows in the chart below.

The short-term outlook continues to look challenging with a break below the recent lows likely to cause another downside extension in the region of $5 per barrel. However, while long (positions) are being reduced, we are unlikely to see any significant increase in new short positions as long the Middle East situation remains as fluid as now.

The demand and growth worries that drove crude oil lower supported gold, which reached a 14-month high that leaves it even closer to challenge the wall of resistance that has capped the market since 2014. Weak economic data from the U.S. and China added further fuel to the belief that central banks, led by the Federal Reserve, will soon embark on another round of easing.

Several failed attempts since 2014 to break higher have frustrated traders and investors alike. However, the combination of Middle East and Hong Kong tensions, as well as rate cut expectations and recession fears, have given the metal some renewed tailwinds. Further support has come from the hedge fund industry, which have been buying record amounts of gold during the past couple of weeks.

From the chart below it is clear to see the technical hurdles gold still faces. Given the outlook for the wider markets, we believe that it eventually will break higher. From a purely technical perspective, a break could see it set sail towards the next target of $1,480 per ounce.

The biggest short-term risks are the potential for the U.S. Federal Open Market Committee proving unwilling to meet the market’s expectations for aggressive rate cuts and/or a surprise trade deal announcement when Trump and Xi meet at the G20 in Osaka June 28-29.

In addition, while hedge funds have supported the recent rally, any price reversal at this stage could trigger a significant amount of long liquidation from recently established longs

Any opinions expressed here are the author’s own.

Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.

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