Summary: A week that saw global stock markets suffer from increased bond market volatility, geopolitical tensions in the Middle East and a so far volatile US earnings season. The dollar traded steadily against a broad basket of currencies while the commodity sector saw weakness in energy and grains, being offset by strength in softs and not least precious metals where a near-record buying pace was maintained in gold.
The energy sector, led by losses in crude oil and diesel, traded lower with the market focus alternating between the risk of a not yet realized and low probability disruption to supply from the Middle East, and weakening fundamentals into the low-demand season. Elsewhere the metal sectors traded mixed with gold attracting most of the buying interest from investors seeking shelter from elevated geo-risks and volatile price action in the US bond and equity market.
Crude oil traders continued to focus more on current fundamentals than the risk of a not-yet-realised supply disruption. During the week they cut their net long in WTI and Brent by 17.4k to 431k, some 129k below the September peak, with the reduction primarily due to 18k lots of fresh short positions.
Crude oil fluctuates with war risks offsetting slowing demand:
Crude oil futures continue to trade rangebound as the war premium related to the Israel-Hamas war continues to ebb and flow in response to news and developments in the region. Since Hamas’ October 7th attack on Israel, the market has in vain been trying to assess and price the risk of a potential, and in a worst case, major supply disruption, but so far, this geopolitical price premium has struggled to exceed five dollars. It highlights the difficulty in pricing a not-yet-realised disruption, knowing that an actual impact on supply, especially from Iran, may send prices sharply higher, while no impact would return the focus to demand which is currently going through a seasonal slowdown.
As mentioned, while the main oil market focus stays on the Middle East, underlying fundamentals have started to ease with demand heading for a seasonal slowdown, potentially made worse by an ongoing economic slowdown. Refinery margins, especially for gasoline, have fallen as we approach the low-demand season thereby reducing refinery demand for crude as profitability falls. Prompt WTI and Brent spreads have more than halved, as supply fears ease, while the premium medium-sour Dubai crude commands over both light-sweet Brent and WTI have both fallen back, another sign that the market remains relaxed about the risk of a Middle East contagion.
While the upside potential remains impossible to predict, downside risks are limited by the existence of a floor beneath the market. Having fought so hard to support the price, and in the process giving up revenues, Saudi Arabia and its Middle East neighbors are unlikely to accept much lower prices. This leads us to believe support for WTI and Brent has been established and will be defended ahead of $80 and, barring any war-related disruptions, the upside for now seems equally limited. With that in mind, Brent is likely to settle into the mid-80s to mid-$90s range, an area we for now would categorize as being a sweet spot, not too cold for producers and not too hot for consumers.
Gold bulls take stock as $2000 looms large:
Gold has now fully recovered from the recent selloff to challenge $2000, a big psychological level. While geopolitical tensions following the October attacks inside Israel were the trigger, buying pressure from funds forced to flip positions back to a net long added to the strong momentum. In the week to October 17, wrongfooted speculators bought 5.7 million ounces of gold – the fourth biggest in the last decade – to reverse an ill-timed short back to a 4.2-million-ounce net long, still well below the 14.8 million ounces long reached during the US banking crisis earlier this year.
It is also worth noting that total holdings in bullion-backed ETFs have yet to show any signs of long-term investors getting back in. Total holdings have been falling continuously for many months with asset managers, many of which trade gold through ETFs, continuing to focus on US economic strength, rising bond yields and potentially another delay in peak rates as reasons for not getting involved. These factors, together with the rising cost of funding a non-interest paying precious metal position, have been a significant driver behind the year-long reduction in gold positions, and in recent updates, we have argued that this trend would likely continue until we see a clear trend towards lower rates, and/or an upside break forcing a response from real money allocators for ‘fear of missing out’.
Gold trades within a very steep ascending channel, which highlights not only the current strength of the rally but also the need for consolidation. Earlier this week, the yellow metal did correct lower, only to find support at the first given opportunity just above $1950. A close above $2000 may signal a move towards the two record closing highs of around $2050 from March 2022, and May this year.
