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Impact of OPEC's decision not to be felt until 2017

Oil&Gas Materials 12 October 2016 16:02 (UTC +04:00)
Commodities remain on track to record their first year of positive returns since 2010, Ole Hansen, head of Commodity Strategy Saxo Bank, said.
Impact of OPEC's decision not to be felt until 2017

Baku, Azerbaijan, Oct. 12

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Commodities remain on track to record their first year of positive returns since 2010, Ole Hansen, head of Commodity Strategy Saxo Bank, said.

But with the Bloomberg Commodity index up by less than 10 percent, it could all still change before year-end. While the energy sector continues to stabilize following a two-year selloff, it has primarily been the precious metals sector with its 26 percent gain that has helped stop the commodity rout.

Global commodity demand has yet to recover as continued questions about global growth are being asked. Instead, most of the gains – apart from those seen in precious metals – have been due to the supply side adjusting, either through cutting production (oil and industrial metals) or through involuntary disruptions caused by weather (softs).

Oil lower for longer

From the vantage point of early 2016, the year’s final quarter was widely expected to deliver a firm recovery for oil prices. Prolonged price weakness, it was thought, would ultimately trigger strong demand growth while reducing high-cost production enough to balance the market.

Instead, the oil market remains locked in a $45 to $50/barrel range from which it will struggle to escape from into year-end.

Rising OPEC supply (both from new production and reduced supply disruptions), together with Russian production hitting new record levels, has once again delayed the rebalancing process. In addition, the past quarter showed emerging resilience among US high-cost producers which are once again adding rigs amid stabilizing oil output.

The pump-and-dump strategy introduced by Saudi Arabia in November 2014 was called off at the September 28 when OPEC members meeting in Algiers decided to cut production by up to 700,000 barrels/day with the allocation expected to be agreed at the next official OPEC meeting on November 30.

The decision was taken to establish a floor under the market with the upside limited until the global overhang of supply start to show signs of being reduced.

The devil's in the details. This was the easy decision compared with the hard bargaining that now lies ahead of the November 30 meeting. If Russia joins, we have a proper deal which could propel oil back to the July level but unlikely higher at this stage.

US producers have been taking advantage of hedging opportunities in 2017 and 2018. Central banks’ experiments with negative yields, meanwhile, have ensured that plenty of investors have been prepared to lend money to the sector. The OPEC deal if successful will also cheer US and other high cost producers considering the potential it provides for stabilizing and eventually boosting production.

On top of all this, we still need higher oil prices in the future in order to attract the investments required to ensure stable supplies.

“During the final quarter we expect the $45 to low 50s range to be maintained for Brent crude oil,” Hansen said. “The deal among OPEC producers to cut production is unlikely to have a major positive impact on prices at this stage. It will, however, reduce the time it takes to bring down the global excess supply overhang of both crude oil and products.”

Hansen said that the lasting impact of such action is not likely to be felt until 2017 on the assumption that global demand growth continues to rise.

In a recent report, the International Energy Agency said that oil demand growth from China and India was slowing at a faster pace than initially predicted as underlying macroeconomic conditions remained uncertain.

Hedge funds provided most of the volatility during the third quarter as the rangebound nature created several false signals in both directions. These signals in turn supported the rapid ebb and flow in speculative positioning, which helped create a great deal of volatility. Heading into the final quarter, funds remain overall bullish but the net-long has been reduced by 40 percent compared the peaks witnessed during April and August of this year.

Precious metals face a volatile quarter

Gold spent most of the third quarter locked in the range established following the Brexit vote on June 23. As the yellow metal continued to trade within a diminishing range (initially between $1,300 and $1,375/oz), the demand from investors began to fade. Total holdings in exchange-traded products rose by 38 percent during the first half of the year but have been almost flat since then. Hedge funds have held an unchanged but still elevated bullish bet for the past three months.

More than physical demand, investment demand has been the main driver behind the price surge witnessed earlier this year. While total holdings through ETPs and money managers’ positions in futures have reached a level just 13 percent below the 2012 peak, the nominal value of this position remains some 35 percent below.

Other drivers which continue to attract attention have been the market’s obsession with the future direction of US short-term interest rates, the dollar, and the general price trends for the commodity sector as a whole.

“We believe that gold’s longer-term direction is higher but the market behavior during the past few months could indicate that the yellow metal may need a longer period of consolidation during which a test of key support below $1,300/oz could be seen,” he said.

From a technical perspective, gold’s post-Brexit rally ran out of steam at $1,375/oz, a level that coincides with a both a trendline from the 2012 peak and a 38.2 percent correction of the selloff seen up until last December.

An eventual break of this level could see gold initially target an extension to $1,485/oz.

Until such time, we view the downside risk being the greatest over the coming months. We would view a potential break below $1,300 as a positive development as it would force the market to react and show its hand.

It is often during times of weakness that the true strength of a market can be gauged and following a 23 percent year-to-date rally, gold may now be in need of such a test.

“With our raised concerns that the dollar may regain some strength during the coming months, we look to gold priced in other currencies for upside momentum,” Hansen added. “According to our forex outlook and intro from Saxo Bank chief economist Steen Jacobsen, some of these alternative currencies could be euro, kiwi, and Japanese Yen.”

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