There have been many events impacting markets over the past month, but when people look back on May 2018, one of the most impactful events will be the U.S. withdrawal from the Joint Comprehensive Plan of Action (JCPOA) and re-establishment of all previous sanctions it had previously imposed on Iran. In our view, the impact on the oil market from simply viewing this in isolation should be minimal, as the U.S. doesn’t import any Iranian oil and Iran only produces about 3.8 million barrels per day of OPEC’s 32 million barrels per day.
The critical factor, rather, is the signal that the U.S. is sending by imposing extraterritorial sanctions—meaning that the U.S. is placing restrictions on all countries doing business with Iran. Most countries—absent any direct evidence that Iran violated the terms of the JCPOA—will do their best to avoid restricting their business with Tehran, and this sets the stage for clashing viewpoints between the policy of the U.S. and the views of much of the rest of the world. How other countries decide to deal with their disagreements with the U.S. on this issue (and potentially others) will likely set the stage for how the commodity markets perform in the months to come.
The US dollar has strengthened considerably over the prior month. The fact that we’re seeing oil’s appreciation in the face of such a dollar move tells us that oil market participants are placing a great deal of emphasis on the geopolitical situation in formulating their view on where prices should be.
Additionally, on 15th May 2018, the U.S. 10-Year Treasury Note saw its yield break through the resistance level of 3.05% for the first time since July of 2011. Some dollar bulls use this as one piece of their ammunition—arguing that U.S. interest rates being so much higher than those in Germany or Japan presages further dollar appreciation. Gold bears also look at this and note that, if one is to believe that U.S. treasuries are risk-free, gold is an asset without a yield and a higher yield creates stronger competition for portfolio allocations against gold positions.
One of the most interesting questions to us in looking toward the next part of 2018 will be whether or not the market aligns the view of geopolitical risk that seems to be embedded in the oil market’s behaviour of rising prices with the lack thereof that seems to currently be present in the gold market’s behaviour of falling prices.
Sentiment improves towards agricultural commodity complex after (US Department of Agriculture) USDA’s latest outlook. Cotton and corn have further to go. Net speculative positioning among most agricultural commodities with the exception of soybean oil turned positive on the back of short covering.
Ample supply situation paves way for lower metal prices, except for nickel. Industrial metal prices came under pressure after the re-assessment of the supply situation from various International Study Groups, projected more supply should be available on most metal markets, paving the way for potentially lower metal prices in the future.
Oil prices continued to rise in May as the risk of supplies tightening increased. Sanctions were reintroduced by the US on Iran with extraterritorial provisions. However, non-OPEC supplies are increasing and demand is likely to be set back by rising prices. Unless these sanctions are enforced by the countries that oppose them, we are likely to see oil prices decline.
Gold prices succumbed to pressure from surging US 10Y yields and a resurgent dollar. Gold has now fallen below its technical support level of $1,300 – a level last seen towards the end of last year. Net long speculative positioning declined to its lowest level since mid-2017, suggesting fading fears of geopolitical risks. In gold’s slipstream, the rest of the precious metals complex were dragged lower.
Sector Overview
Agriculture
The agricultural sector was led higher by lean hog, wheat, corn and cotton prices last month. The USDA released their first projections for 2018/19 crop, forecasting lower ending stocks for corn, wheat and soybeans compared to consensus estimates.
A large part of wheat’s upward price momentum so far can be attributed to reports of winter wheat plants being in poor condition in Kansas. USDA surprised investors by projecting a 5% increase in US wheat production owing to a sharp rise in spring wheat despite the ensuing poor winter wheat conditions. Despite the 15% decline projected for the Russian wheat crop, global wheat stocks are expected to be only 2% short of the 2017/18 all-time high. As inventories remain elevated, we expect wheat prices to correct to the downside.
The significant decline in world corn ending stocks projected by USDA, pegs the world’s stocks to use ratio at just 14.5% from 21.8%. This marks the second tightest world’s stocks to use ratio for corn since the 1973/74 season. The price incentive offered in cheaper corn-based ethanol used in fuel production compared with rapidly increasing crude oil prices is resulting in more corn being used for fuel than traditional feed purposes in 2018. The reduction in corn cultivation in China, after it already cut back its high stocks in 2016/17 and 2017/18 season is likely to contribute to a more pronounced decrease in global corn stocks. Corn prices are poised to potentially benefit in the long run however as corn enters the prime growing season starting in June, it remains exposed to significant price pressure.
Industrial Metals
Industrial metal prices came under pressure after the re-assessment of the supply situation from various International Study Groups, projected more supply should be available on most metal markets, paving the way for potentially lower metal prices in the future. The most notable change was in the copper market where a moderate supply surplus was envisaged in 2018, the first in nine years, owing to higher mining and refinery production. It is yet to be seen if the collective agreements between the mine operators and the union, will be extended at the Escondida mine in Chile mid-year. Last year, the strikes at the Escondida mine caused significant supply outages on the copper market. The slowing dynamism in the Chinese construction sector coupled with weak growth of fixed asset investment in China at 7%, its lowest reading since 1999 pointed to weak demand.
Nickel was the best performer in May among the industrial metals complex supported by a favourable demand situation from stainless steel and battery technology. Global stainless-steel production (largest nickel consumer by far) climbed by 5.8% last year and is expected to expand a further 5% to a new record high of 50.5mn tons, according to consultancy MEPS. Despite a sharp rise in primary nickel production, the International Nickel Study Group (INSG) expects a large supply deficit of 120,000 tons this year. LME stocks have declined by over 60,000 tons so far this year, reaching their lowest level since July 2014. According to Shanghai Metals Market (SMM), nickel ore stocks at Chinese ports have reduced by 33% to 7.6mn tons over the past 6 months. We remain optimistic on the long-term investment case for nickel as supply lags rising demand.
Energy
The US has decided to withdraw from the Joint Comprehensive Plan of Action (JCPOA) and reinstate all previous sanctions it had previously imposed on Iran. Although the US does not import any Iranian oil, the sanctions are designed to be extraterritorial – thus placing restrictions on all countries doing business with Iran. As Iran has not violated the terms of the JCPOA, most countries oppose the reintroduction of sanctions and will do their best to avoid restricting business with Tehran. On May 18th the European Commission for example put forward a Blocking Statute which forbids EU companies from complying with the extraterritorial effects of US sanctions and allows companies to recover damages arising from such sanctions. With Iran producing 3.8 million barrels per day (of OPEC’s 32 million barrels per day), the threat of supply restrictions had sent oil prices over US$80/bbl for the first time since November 2014. If countries can successfully bypass US rules, we expect oil prices to ease.
However, the threat of US sanctions against Venezuela is now emerging following a suspicious election results that sees the incumbent Nicolas Maduro remain in power despite widespread disillusionment with his performance. Venezuelan oil supplies have been plummeting as a result of economic disarray and sanctions against the country could further tighten supplies from the country.
The (Energy Information Administration) EIA expects US oil production to rise by 1.3 million barrels per day in 2018, following a 0.46 million barrel per day increase in 2017. The EIA’s latest forecast for 2018 is 0.4 million barrels per day higher than last month. The market appears to be ignoring much of the price negative news from the US supply increases amid the extent of geopolitical news elsewhere.
Precious Metals
Gold prices have weakened over the past month with the US 10Y comfortably above 3% and the dollar up nearly 5% since mid-April. Both developments are bearish for gold. Although gold seemed to be carrying a geopolitical risk premium earlier this year, its divergence with oil lately indicates that political concerns rank lower on gold investors’ minds in recent weeks. However, Iran’s potential withdrawal from the Joint Comprehensive Plan of Action and the upcoming meeting between Trump and Kim Jong Un in June remain key risks that could derail risk-on sentiment and preserve gold’s shine.
Silver has moved in lockstep with gold for much of 2018 and this trend continued over the past month. The gold to silver ratio has declined over the past month, indicating more bullishness towards silver than gold.
Technical Overview
Positioning
Speculative positioning in soybean oil futures became the most bearish since April 2017, shorts built up again, ending our reporting period 514% more net short than the prior month. Net positioning among wheat, corn and coffee rose higher by 177%, 31% and 47% respectively as a consequence of short covering. While sentiment has improved towards corn and wheat futures following USDA’s latest outlook, investors remain bearish on coffee futures as long positions declined further.
Investors appeared more cautious on nickel, as net speculative positioning declined 47% as investors built up short positions by 5%. Net speculative positioning in Brent oil futures have come down marginally from an all-time high reached in last month.
Net long speculative positioning in gold has fallen to around 100,000, its lowest level since mid-2017 and just below the five-year average. This suggests speculators are sceptical of a material geopolitical risk developing. Positioning in silver is currently less negative than last month (when it hit an all-time low), but still remains more than a standard deviation below its five-year average.
Inventories
Corn ending stocks have declined 21.6% over the period. USDA projected global corn ending stocks to decline 35.8mn tons from a year ago, and if realised would be the lowest since 2012/13. According to USDA, the global coarse grain outlook is for higher production, increased use and lower ending stocks.
Soybean inventories have decreased 11.7%. Despite USDA projecting global soybean production to rise on the back of a recovery from the drought in Argentina, higher soybean crush and exports are expected to offset most of the rise as global soybean ending stock estimates are lowered by 5.5 million.
Tin inventories rose 35% on average over the prior 3 months. China’s impact as net importer to net exporter is starting to be felt, as tin inventories on the Shanghai Metals Exchange (SHFE) rose sharply by 71% the last month alone.
The International Lead and Zinc Study Group (ILZSG) expects the 2018 zinc supply deficit of 263,000 tons to be lower than last year since production is expected to pick up noticeably. As sentiment remains less upbeat than a month ago, we expect zinc prices to correct further.
Natural gas inventories are rising in line with seasonal trends, but remain significantly lower than last year and 27% below the 5-year average as the coldest April in 21 years led to lower than-normal injections. However, the EIA expect higher production in coming months to the close the gap between current inventory levels and the 5-year average to just 8%.
Curve Dynamics
With the exception of cotton, the extent of the decline in contango along the short end of the agricultural commodity futures curve suggests ample supplies.
Although Brent and WTI oil are in backwardation through most of the curve, heating oil is the only energy future in backwardation in the front month, with a positive roll yield of 0.3%.
Technicals
Coffee is currently trading 7.7% below its 200-Day Moving Average (dma) and we expect to see further price weakness owing to expectations of a record coffee crop in Brazil. Owing to ethanol’s attractive price discount to gasoline prices, a marked shift in sugar cane processing in Brazil away from sugar towards ethanol is likely to persist. This could lend some support to sugar prices that are currently 15% below their 200-dma.
Carbon is trading 68% above its 200-day-moving average as an effort to tighten up the supply of permits under the European Emissions Trading Scheme is likely to take place to reduce emissions by 40% by 2030 to be consistent with the commitments under the Paris Agreement in 2015.
Gold traded below its technical support level of $1,300 and is now at its lowest point since the turn of the year.