By Ole Hansen
In gold we trust. At least up until the election.
- Precious metals gain on election fears, but oil and gas hammered
- We still believe that Opec will reach a deal of some sort
- Bloomberg commodity index had its worst week in four months
- Zinc hits a five-year high as Chinese data improves
- Cost of precious metals calls options relative to puts jumps most since 2008
Nov 6 – With just a few days to go before the U.S. presidential election, some major moves were seen across commodities this past week. Some, especially precious metals, were related to the U.S. race while others, such as oil, were driven by OPEC inaction and industrial metals by improved China data.
The Bloomberg commodity index which tracks the performance of key commodities had its worst week in four months, with the energy sector loosing 9 percent as both oil and natural gas got hammered. Industrial metals, led by zinc which reached a five-year high, moved higher in response to a pick-up in manufacturing activity in China and the U.S., the world’s biggest consumers.
As the stock market fear index kept rising ahead of next week’s election, so did the price of precious metals. Gold recovered all the losses seen at the beginning of October while silver found dual support from its role as both an investment and an industrial metal.
The gap between U.S. presidential Democrat nominee Hillary Clinton and Republican nominee Donald Trump narrowed sharply during the final full week of campaigning ahead of the November 8 elections. This increased uncertainty caused a tremor across the markets with the dollar and stocks weakening while the VIX jumped the most since the Brexit vote back in June. Precious metals, meanwhile, saw renewed demand with the cost of calls options relative to puts jumping the most since the Lehman crisis in 2008.
Gold’s recent rally has been driven by a combination of a weaker dollar, rising inflation prospects and not least raised uncertainty about the outcome of the U.S. election.
While the Brexit vote back in June caused a major initial upset to the market, the impact was eventually limited to U.K. stocks and the pound. A Trump win, however, could have a global impact considering his protectionist trade policies that may weigh on US economic growth, interference with the rate setting at the Federal Reserve combined with expectations of higher government spending and greater geopolitical risks.
A Clinton win would likely trigger an initial reversal and this is the reason why this binary event is being approached through the use of call options. The one month risk-reversal with a 25 percent delta favored calls by just 0.5 percent a week ago but during the week it surged by almost 3 percent, the biggest jump since 2008.
After reaching a low at $1,242/oz in the aftermath of the October 4, selloff gold initially spent a couple of weeks consolidating while long-liquidation from funds exiting what was an elevated long continued. But with a December U.S. rate hike fully priced in, attention began turning to the upcoming election. Before then a sharp selloff in bonds – now recovering – did not attract gold selling as it was matched by an almost equal rise in forward inflation expectations, thereby leaving the important real yield close to zero.
We believe the worst is over for gold and that multiple sources of support apart from the election including rising inflation fears and stock market uncertainty will support a renewed recovery lasting into 2017. The key level remains the July high as a break above would increase the potential of an extension towards $1485 over the coming months.
OPEC in the process of scoring an own goal
After keeping the market supported by verbal intervention on numerous occasions this year. OPECfinally promised action back in September when they met in Algiers. The details of an agreement to cut production was going to be announced at the OPEC meeting on November 30. This would leave the cartel plenty of time to sort out the details about who should cut and by how much.
At the World Energy Congress in Istanbul on October 10 Vladimir Putin also gave an indication that Russia would be prepared to join OPEC in limiting oil production with either a freeze or a cut. As a result of these development oil rallied strongly back above $50 with increased calls for $60 being the next stop.
Hedge funds bought into this prospect and by October 11 they held a gross-long position in WTI and Brent crude oil of 840 million barrels, this following the biggest surge in buying ever seen.
That was then and now just one month later oil has seen the biggest weekly loss in 10 months while a 16 percent selloff from the October 10 peak has wiped out all the gains since the Algiers meeting with $40/b now being talked about instead of $60/b. What has changed?
Several OPEC members including Iran, Nigeria, Libya and most recently Iraq all want to be exempt from cutting production while Russia have returned to their stance of only wanting to, at best, to freeze production.
Production surveys covering October pointing towards record production from OPEC with increased supply coming from Nigeria, Libya and Iran while Russia also reached a post-Soviet record. These developments were topped with the biggest weekly rise in U.S. inventories on record and as a result, hedge funds have been scrambling to get out of failed and now loss-making bets on rising prices.
A rapid liquidation phase of overextended positions, both long and short has been a key driver behind several of the 20-25 percent moves – both up and down – witnessed during the past couple of years. While the first signs of market support from Saudi Arabia back in August helped drive a big short out of town as the market rallied by 22 percent, we are now seeing the opposite, and without renewed focus on production cuts, this current selloff may not stop before longs are reduced and this could take it back down to $40/b.
Increased supply from Nigeria and Libya and forecasts for a busy loading season from the North Sea has put prompt Brent crude oil spreads under pressure. A deepening contango is a strong sign of an oversupplied market. The six-month spread between January and July as seen below trades at $4/b. A spread this wide has once again opened up for storage plays at sea. Buyers take delivery of oil, put it out to sea on a rented supertanker for six months and make profit from selling at a forward price some 9 percent higher than prompt.
The latest selloff in oil came following last week’s technical meeting in Vienna where OPEC and non-OPEC producers failed to reach consensus on who should cut production, let alone by how much. Reuters on Friday reported that old disputes between Saudi Arabia and rival Iran resurfaced at the meeting with Riyadh threatening to raise output steeply to bring prices down if Iran refused to limit its supply.
Looking ahead we remain of the belief that OPEC, with the risk of a renewed price collapse will reach a deal (of some sort) as most members can ill afford a prolonged delay in achieving market balance. Whether such a deal will do more than help stabilize the price remains to be seen. The road towards recovery and re-balancing continue to be extended with OPEC and its lack of co-operation increasingly being the main reason.