This article presents the current turmoil in the commodities market, together with the author’s opinion on the short-term price outlook of oil and gold prices moving forward based on an analysis of current issues in the news.
Global Economic Events
China and the U.S. have implemented several rounds of tariffs on exports, with further threats of duties on hundreds of billions of dollar worth of goods. Currently, we see that investors are worried about the prospect of a slowdown in global economic growth which will dampen commodity prices.
We have seen some respite in terms of oil prices as Chinese and U.S. negotiators are planning talks to resolve their trade dispute ahead of meetings in November. Mexico also hopes to wrap up the bilateral issues on the North American Free Trade Agreement (NAFTA) within the next week.
Figure: USD-TRY (Turkish lira) Exchange rate, year-to-date
The crisis surrounding the Turkish lira has unstabalised emerging markets and this has been reflected across the equity markets and commodity prices. With the Turkish lira dropping 40% in value at one point in time over the past week, this has rattled other emerging markets. Emerging market currencies are weakened as compared to the U.S. dollar and this will weigh down on commodity prices. Negative sentiments towards weaker global economic growth is increasing, and this hurts demands for raw materials and commodities.
In the past year, much of the focus on commodities was towards the supply-side. Due to the rise of the trade dispute and Turkish lira devaluation, there has been a clear shift of focus towards the demand-side factors. Investors are increasingly bearish on future economic growth due to the aforementioned factors, and this effect can be clearly seen in the stock markets in the past week. Commodities, in general, are hit the hardest. For example, ASX-listed Rio Tinto (ASX:RIO) and BHP Billiton (ASX:BHP) has seen a drop in share price of 12% and 8% respectively since the beginning of August. Most, if not all commodities have fell into a bear market with the rise of global economic uncertainty due to the trade dispute and the troubles with Turkish lira and other commodities.
With the Fed set to increase interest rates two more times by the end of fiscal year 2018, coupled with the protectionist measures carried out by the U.S., the U.S. dollar has strengthened considerably. A stronger U.S. dollar means bad news for global demand for commodities. Commodities like gold are traded in the U.S. dollar, and a stronger U.S. dollar means that emerging markets with strong demand for metals like China and India have less purchasing power, resulting in a decrease in demand for some commodities.
However, we have since seen a recovery in other sectors. Commodities stocks, however, are still on the downward trend. This article shall look at the short-term oil and gold outlook in greater detail.
Asian demand for oil is lowering as the U.S. – China trade dispute and a stronger dollar are slowing the economies of the world’s largest oil buyers (i.e. China and India). In the past few years, crude oil demand from Asian oil importers has been stagnant. Thus, the trade dispute might have strong implications towards the demand for oil, especially from China.
Emerging markets are expected to contribute an additional 1million barrels of oil demand in 2018. Weaker emerging market currencies will also weigh down demand for crude oil.
There is a large build-up in U.S. inventories for crude oil which poses questions about the price outlook into the future. In theory, we can clearly see that this build-up in crude oil inventory seems to be insignificant. However, with the increasing U.S. crude oil production and operational U.S. oil rigs, we see that U.S. has the potential to raise its supply of crude oil in the near future.
As OPEC’s third largest producer, Iran has since faced fresh sanctions and market watchers have expected oil output from Tehran to decrease by a third by the end of 2018. OPEC has agreed to increase production to supply an extra 700,000 barrels per day in June. There have been huge disagreements between Iran and OPEC as Iran is opposing the increase in production, as this will pave the way for U.S. sanctions to follow through as the increase in OPEC oil output will cushion the blow from the drop in output from Iran. However, OPEC has only increased supply by 41,000 barrels per day by July, which means OPEC still needs to increase production by a large amount in order to make up for the expected shortfall in the coming months. This goal will be further weighed down by Venezuela’s uncertain oil output given its current political and economic turmoil.
U.S. sanctions on Iran will certainly place upward pressure on oil prices. According to trade data from Thomson Reuters Eikon, China will be likely to ignore U.S. sanctions and continue importing oil from Iran. However, that is where the support for Iranian oil ends. India, South Korea, and Japan are prepared to obtain its oil from alternative suppliers if the U.S. does not grant them any sanctions, this should be expected as well given the longstanding relationship between the U.S. and the aforementioned countries. Most European countries have stopped their purchases of Iranian oil, but key importer Turkey will continue to import oil from Iran, given its deteriorating relationship with the U.S. Overall, an estimated 700,000 to 1 million barrels a day will be taken off the global oil markets.
Overall Oil Outlook
The global benchmark Brent has been in the red for three consecutive weeks, but has been creeping up in the past week, closing in at US$73.25 on 22th August 2018. The pressure on broad selling of industrial commodities have pressured crude oil prices downwards but the trends have since reversed in the past week.
Going forward, oil prices should rise slightly by the end of 2018. This can be attributed to the reduction of supply of Iranian oil which will be in full effect by the November 4th deadline set by the U.S. Furthermore, the uncertainty of supply from Venezuela and Libya will add further pressure on OPEC to increase its production further to maintain adequate supply of oil. The increase in oil prices will be slightly mitigated by the global economic uncertainty due to the trade dispute between U.S. and China which is unlikely to be resolved in the near future; this will dampen expectations for oil demand, which will keep the increase in oil prices at modest levels.
Gold has dropped to its lowest level since January 2017, reaching $1,197 an ounce, down from $1,300 recorded in the start of 2018. As expected, most gold mining shares are also in the red. For gold, the focus is on demand-side, since the suppliers of gold and gold ore are relatively stable.
Figure: Gold demand for Q2FY17 and Q2FY18
Source: World Gold Council, Metals Focus
Gold has been hit by a decrease in demand from central banks, ETFs and other investments. The demand from this segment will be likely to decrease further, with the increase in interest rates in the U.S. and the overperforming equity markets. However, it is not the main determinant of demand for gold as it only makes up a small portion of gold demand as seen above, hence we will not expect there to be huge fluctuations due to current geopolitical headwinds.
Nonetheless, the U.S. dollar is strengthening and this may cause greater trouble ahead. With demand for gold jewellery primarily made up by China and India, the weaker yuan and rupee means that the country loses purchasing power. Ultimately, this will be the main driver for gold prices moving forward. In that case, gold might have even further to fall, since U.S. will be increasing its interest rates twice by the end of 2018, which will cause the U.S dollar to strengthen even further. Coupled with the currency trouble in other emerging markets and the uncertain global economic outlook, it seems that gold might not have seen the end of the bear market.
Sources Referenced and Further Reading
Ahman Ghaddar et.al. (2018). As sanctions start to bite, Iran crude exports set to wilt. Retrieved from https://www.reuters.com/article/us-iran-oil/as-sanctions-start-to-bite-iran-crude-exports-set-to-wilt-idUSKBN1K709A
Alex Longley (2018). OPEC lifted crude production in July. Retrieved from https://www.bloomberg.com/news/articles/2018-08-13/opec-lifted-crude-production-in-july-despite-saudi-supply-cut
Bloomberg News (2018). China, unsure of how to handle Trump, braces for ‘New Cold War’. Retrieved from https://www.bloomberg.com/news/articles/2018-08-17/china-unsure-of-how-to-handle-trump-braces-for-new-cold-war
Christopher Alessi (2018). OPEC’s output rose in July despite decline in Saudi oil production. Retrieved from https://www.wsj.com/articles/opecs-output-rose-in-july-despite-decline-in-saudi-oil-production-1534159267
Erin Douglas (2018). Oil edges higher on anticipated U.S.-China trade talks. Retrieved from https://www.bloomberg.com/news/articles/2018-08-16/oil-holds-losses-near-65-after-surprise-gain-in-u-s-stockpiles
Erin Douglas (2018). Oil posts longest losing run since 2015 amid economic fears. Retrieved from https://www.bloomberg.com/news/articles/2018-08-17/oil-set-for-longest-weekly-losing-streak-since-2015-on-turkey
Erin Douglas (2018). Oil sinks to 10-week low after surprise U.S. stockpile build. Retrieved from https://www.bloomberg.com/news/articles/2018-08-15/oil-drops-for-a-third-day-as-a-report-shows-u-s-stockpiles-rose
Grant Smith (2018). Oil supply fears have abated as production rises, IEA says. Retrieved from https://www.bloomberg.com/news/articles/2018-08-10/oil-supply-fears-have-abated-after-production-boost-iea-says
Jeff Cox (2018). Fed hikes rates, points to two more increases by years’ end. Retrieved from https://www.cnbc.com/2018/06/13/fed-hikes-rate-by-a-quarter-point.html
Jessica Resnick-Ault (2018). Oil rises in session, but has weekly loss on trade worries. Retrieved from https://www.reuters.com/article/us-global-oil/oil-rises-in-session-but-has-weekly-loss-on-trade-worries-idUSKBN1L203M?il=0
Jessica Resnick-Ault (2018). Oil steadies but outlook for demand grows gloomy. Retrieved from https://www.reuters.com/article/us-global-oil/oil-steadies-but-outlook-for-demand-grows-gloomy-idUSKBN1L105W
Jessica Summers (2018). Oil slides as industry reports surprise increase in crude stocks. Retrieved from https://www.bloomberg.com/news/articles/2018-08-14/oil-rebounds-as-stockpile-drop-seen-countering-turkey-selloff
Luiz-Ann Javier et.al. (2018). Commodities take global hit as Turkey, China form toxic combo. Retrieved from https://www.bloomberg.com/news/articles/2018-08-15/commodities-take-global-hit-as-turkey-china-form-toxic-combo
Nick Wadhams (2018). U.S. forecasts 50% cut in Iran oil sales, missing goal. Retrieved from https://www.bloomberg.com/news/articles/2018-08-10/u-s-is-said-to-forecast-50-cut-in-iran-oil-sales-missing-goal
Siddhartha Singh et.al. (2018). India mulls 50% Iran oil cut to win U.S. waiver. Retrieved from https://www.bloomberg.com/news/articles/2018-08-14/india-is-said-to-mull-50-percent-iran-oil-cut-to-win-u-s-waiver
Stephen Culp (2018). Wall Street rises on upbeat trade news. Retrieved from https://www.reuters.com/article/us-usa-stocks/wall-street-rises-on-upbeat-trade-news-idUSKBN1L215L?il=0
Wael Mahdi et.al. (2018). OPEC+ to boost oil output after Saudis secure deal with Iran. Retrieved from https://www.bloomberg.com/news/articles/2018-06-22/opec-is-said-to-have-deal-in-principle-with-iran-for-output-hike
World Gold Council (2018). Gold Demand Trends Q2 2018. Retrieved from https://www.gold.org/research/gold-demand-trends/gold-demand-trends-q2-2018
Gold prices retrieved from https://www.bullionstar.com/charts/