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ANALYSIS

Ole Hansen

Trumponomics, Opec remain key commodity drivers

By Ole Hansen, December 11, 2016

The Bloomberg Commodity Index is currently up 12 per cent in 2016 and it remains on track to record its first year of gains since 2010. All sectors apart from agriculture are showing gains of more than 10 per cent with industrial metals on top having returned more than 25 per cent.

The impact of the Trump win on November 8 continues to be felt across all asset classes with the prospect of growth friendly policies and the potential of rising inflation having led to new record highs on Wall Street while bond yields have spiked and the dollar has rallied. In addition to this, Opec's decision to cut production meant that November certainly turned out to be a month full of surprises.

The major commodity sectors, with the exemption of precious metals, traded higher during the past week, this despite the continued headwind from a rising dollar. Crude oil paused following the strong surge ahead of a meeting of non-Opec producers (NOPEC). Natural gas, meanwhile, raced higher as a polar blast helped send US prices to a 2-year high.

Industrial metals maintained the strong gains from the past couple of months on raised demand from China while precious metals tried to put up a fight against the stronger dollar.

A continued surge in stocks combined with rising bond yields and a stronger dollar have caused a great deal of uncertainty with regard to the future direction of precious metals. Total holdings in exchange-traded products backed by gold have declined by 164 tonnes since November 8 while hedge funds have cut bullish bets by more than 60 per cent since the July record.

Options traders maintain a negative bias but while put options a couple of weeks ago were priced 3 per cent above calls, the most negative in 15 months, that premium has now narrowed to just 0.6 per cent. In the futures market the open interest has stabilised and that could also be a sign that the selling pressure from long-liquidation has begun to fade.

Another sign of the market stabilising is the gold-silver ratio which has slipped back below 70 with silver outperforming again. Some of it undoubtedly has come from the white metals link to a surging industrial metals sector but it also shows that positions have adjusted to the new and lower levels.

The gold-silver ratio is lower, a sign of fading selling pressure given silvers usual tendency to underperform gold during set-backs.

With only one full trading week left before the markets settle down for the holiday season there is just one major event left in the financial calendar. On December 14 the last Federal Open Market Committee meeting of the year is widely expected to deliver only the second rate hike in this cycle which began one year ago.

With the market fully expecting a rate hike, a relief rally might be seen but the extent to which it will be allowed to continue depends on the forward guidance from the FOMC. Growth and inflation expectations are currently on the rise and with Trump's presidency expected to add to both, not least inflation, the FOMC may be forced to turn more hawkish into 2017.

Following the biggest monthly fall in three years gold has managed to trade in a relatively tight range so far this month with the average price not surprisingly being close to $1,172/oz. This is a key technical level as it represents a 61.8 per cent retracement of the December-15 to July-16 rally.

The winner of this bull versus bear fight could ultimately set the direction for gold over the coming months. A bounce from here would indicate that the selloff since July was "just" a deep correction within the uptrend that began a year ago while a break lower would signal a prolonged period of weak price action.

On that basis the fact that gold has managed to hold onto $1,172/oz could be an early indication that demand from other sources than ETPs has started to return. But in order to see a change in sentiment back towards neutral gold needs to climb back above resistance at $1,200/oz. In the short-term, however, a resumption of dollar strength, especially against the euro below €1.05 and the yen above ¥115 will continue to challenge gold's resolve.

The crude oil market had a relatively quiet week following the big spike in the aftermath of the Opec agreement on November 30 to cut production by 1.2 million b/d. The outlook for the market balancing sooner than expected triggered a major rotation of speculative short positions into additional longs. The extent of this change will be known after the close Friday once the CFTC releases data covering hedge funds positioning for the week ending December 6. More on that in my Monday update on Tradingfloor.com.

An important component of "selling" this production cut to the market was the commitment from non-Opec producers to reduce production by an additional 600,000 b/d. A meeting in Vienna on December 10 between Opec and non-Opec members will give a clue whether this additional cut is achievable. Russia has so far promised to gradually reduce production by 300,000 b/d as long Opec complies with its own production cut.

The latter may still become an issue with Opec's poor record when it comes to complying with its own production targets. This could be made even more difficult considering the rising production seen from Libya and Nigeria, both exempt from cutting production. In November they raised production by a combined 140,000 b/d in November with Nigeria looking to add an additional 400,000 b/d before February.

These developments continue to leave many sceptical about the additional upside potential for oil at this stage. However, the improved technical outlook has left the market with a bullish bias and in the short term the market has the potential to move higher. The higher it goes the bigger the risk of a sharp reversal once a lack of compliance from Opec or positive production news from the US shale oil industry begins to emerge.

An additional source of supply over the coming months could come from abandoned storage plays on land and at sea as the economics behind such strategies evaporate. Investment demand at the front and producer selling (hedging) further out the futures curve has triggered a sharp decline in the contango. This has removed the incentive to buy oil for storage to be sold at a future date. Instead we could see tens of millions of barrels being released into the market over the coming weeks and months.

A head and shoulder formation that has been developing since September 2015 has the potential of triggering additional upside to oil. Traders using technical analysis often trade markets without looking at the underlying fundamentals. At this stage in the oil price recovery phase the risk of increased supply from higher prices may eventually prove counterproductive.

Before that happens there is a risk once again of seeing bullish bets rise to an unsustainable level. This could leave the market exposed to a large and potentially unjustified correction as seen on numerous occasions this past year.

Ole Hansen is head of commodity strategy at Saxo Bank, a leading multi-asset trading and investment specialist. His Twitter account was cited by MarketWatch as one that investors should follow in 2016.




Tags: Gold | Wall Street | Trump | commodity prices |

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