Two steps forward and two steps back
It’s hard to look beyond anything but a bearish outlook for the short and medium term in any of the markets this blog covers. The European space continues to lack firm direction and has few options left to play. Understandable German domestic resistance coupled with ongoing issues with Spain and Italy are well documented but unresolved and present significant downside risk. The non-Eurozone European nations – most notably the United Kingdom – are burdened with a shrinking tax base, ageing labour market and stagnate growth.
The outlook for the Americas’ looks more upbeat but still cautious. Brazil continues to drive South America whilst recent GDP data in North America still points to a weak, but positive, outlook. A stagnent labour market in the United States and political risk around the Presidential election will be persistent issues throughout Q4. A Romney win may increase the likelihood that the US would actively support intervention in Iran but this must be offset by the increased pressure sanctions and a devaluing Rial are having.
Tensions between Japan and China over the specks of rock afloat an ocean of oil in the East China Sea represent a low chance/high impact potential flash point. Posturing on both sides and the slowing economic growth in China are of concern. Any slow down in Chinese demand would impact all commodity classes.
Crude Oil – Saudi supply support but upward pressures remain
As always, the direction crude oil will take over Q4 will be heavily shaped by decisions in Saudi and her neighbours. Q2-12 had seen a continued downward pressure on Crude Oil prices with lows of $86/bbl and $76/bbl for Brent and WTI. These trends were reversed in Q3 with Brent holding strongly about $105/bbl centring around three main drivers; stronger US growth reducing inventories, Syrian and Iranian tensions and a moderate return of speculators to the market. Some of the heat we’ve seen cool at the end of the Q3-12 has to be taken as an indication of some profit taking but these cannot account for the entire movement. Early concerns as to how the restrictions placed upon Iranian oil would impact were eased due to pre-emptive consumer action and increased Saudi production; Riyadh continues to consult with refiners and shows willingness to utilise its spare capacity (currently 2.6mbd or 26% of production) to buffer the market and to see a reduced price to prevent any Strategic Petroleum Reserve utilisation. Indications are that domestic infrastructure in Saudi requires a Crude price in the region of $80 and the speculative length we’ve seen recently coupled with an openness to ramp up supply could mean there’s still downward flex.
However, concerns over the situation in Syria and any potential interventions in Iran by Israel add spice to what is already a fruity mix. Without US support, and none will be forthcoming until at least the Presidential election has passed, any attack on Iranian Nuclear facilities will be unable to do significant long term damage. It is the view of this blog that an all out Israeli attack is unlikely. Geo-political factors are not the only potential inflator of Crude Oil price and the Fed’s commitment to quasi-unlimited easing should pump prices.
Thermal Coal – All eyes on weak Chinese growth
The demand for coal global, and that essentially means China domestically, is looking strongly bearish. A saturated market looking for upside can only turn to China to drive increased demand and weak economic growth numbers do not look favourable. Both API2 and API4 look likely to retract and hold in the $80’s/mt.
Whilst total electricity production in China is still increasing year-on-year (c12%), the proportion derived from thermal coal is actually in reverse (down 7%). Additionally the amount held in port stockpiles – a good indicator of near term demand – has fallen by 24% compared to 2011 pointing to this trend starting to have the feel of a permanent move.
Gold – Liquidity and IR’s to continue upward support
Gold trended upwards during Q3-2012 on the back of ECB support for the EUR and the much anticipated third round of quantitative easing. On 13th September, the Fed announced that the would buy $40bn of mortgage securities in an open-ended programme. Additionally, the Fed indicated that it expected to hold interest rates at current levels for the next three years. Inflationary fears on the back of the Feds monitory policy and weak USD support a bullish position on Gold.
Looking at futures market positioning, net speculative length has increased markedly since mid-August. There is little doubt that these moves were as a result of raised expectations of Fed QE after Bernanke’s Jackson Hole speech, and were further heightened by the worse- than-expected US payrolls number at the beginning of September. As it turns out, these expectations were well founded. Looking at previous post-QE announcement reactions, after an initial pull-back in net speculative length, we would expect upward momentum to return and remain in place for some time.
As would be expected, after gold’s rally above USD1,700 during September, net physical gold demand weakened despite seasonal Indian wedding buying. As we have seen before, the physical market will eventually adjust to the higher price level and buying will begin again. However, given that Q4 is usually a weaker period of demand, the positive view on gold over the next quarter does not rely on support from the physical market.