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ANALYSIS

Hansen ... China slowdown major concern.

Oil: Need to scale back production?

, July 29, 2015

By Ole Hansen

There's red ink everywhere this week as commodities crash to levels unseen in 13 years, spooked by fears of a US rate hike and a Chinese economic slowdown. Where could reverse the slide? For some individual commodities the answer is improved demand, for others, such as oil, scaling back production is what's needed, said an industry expert.

The current commodity rout which has seen the Bloomberg commodity index fall to its lowest level in 13 years has now also caught up with gold and during the past week the yellow metal plunged dramatically to a five-year low, explained Ole Hansen, head of commodity strategy at Saxo Bank, an online multi-asset trading and investment specialist.

The heavy selling of metals, both precious and industrial, has been driven by worries about the outlook for Chinese growth.

The recent one-third selloff in Chinese stocks, which has been halted (for now) via government intervention, will have a negative impact on an already weak consumer confidence. After the realisation that stocks were not the new nirvana after the property boom, many Chinese investors and consumers now seek capital preservation more than capital spending.

Gold bears on the prowl

Returning to gold, it's been on slippery slope during the past couple of months with the outlook for rising interest rates in the US triggering reduced investment appetite for it. The fact that the Greek debt crisis and the Chinese stock market rout failed to reignite a safe haven bid was what broke the camel's back. Speculative investors such as hedge funds increasingly turned against gold and a record short position was established during the past month.

A bearish sentiment towards the metal was building as the focus turned from Greece to renewed dollar strength and a hawkish Fed chief, Janet Yellen. News from the Peoples Bank of China on Friday that it had bought much less gold for its reserves during the past five years than the market had been expected, ensured a technically weak close last Friday. This left the market exposed to a speculative run to the downside and that's what happened in the early hours of Monday in Asia.

Gold – a drop below $1080/oz would be a 50 per cent retracement of the decade-long rally
 
“Since then we have seen investor confidence being sapped further while the bearish sentiment towards gold continue to rise with speculative short positions growing while holdings in exchange traded products backed by physical gold have retreated further,” said Hansen.

“As a result we have seen the stock prices of the world's biggest producers of the precious metal taking a hit: a benchmark of 30 leading US gold and silver producers has fallen to its lowest level since 2001. With the selling pressure also seen among industrial metals such as copper, the FTSE350 mining index has fallen to its lowest level since 2009.

“The commodities selloff has now obliterated most of the gains seen during the previous decade when Chinese growth consistently hit double digits. As China now slows (and probably by more than what official data is telling us) the near-term outlook for commodities looks very uncertain. In order to stabilise supply and demand fundamentals we either need to see demand pick up or production of some oversupplied raw materials, such as oil, copper, iron ore being scaled back.

 Gold's price development from here depends on several things, not least the trajectory of US interest rates where the Federal Open Market Committee has so far been more hawkish than the market. Another key factor for gold is the direction of the dollar: several experts, including our head of FX strategy, now reckon we'll have parity to the euro within months. And a stronger dollar, of course, would be bad news for gold. On the other hand, opportunistic buying from central banks and potential production cutbacks would give gold prices some support.

In the immediate term, however, gold is at risk of falling below $1080, a level which represents a 50 per cent retracement of the 10-year rally. We have that as our line in the sand and a break below would result in us downgrading our end of year estimate from its current $1275.

The best chance of a recovery at this stage comes from either a deteriorating outlook for stocks or from those holding a record short position. A reduction of these for whatever reason could potentially drive the price higher by an estimated $50. – TradeArabia News Service




Tags: Gold | Commodities | oil production | Saxo Bank |

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