By Ole Hansen, Head of Commodities Strategy, Saxo Bank
After commodities swung back to gains in 2016, a number of hurdles must be cleared for them to extend this performance in 2017, not the least of which will be oil producers’ ability to deliver the promised and required cuts to rebalance the market.
The Bloomberg commodity index swung to profit in 2016 for the first time in six years. Representing the performance of major commodities, with one-third in energy, metals and agriculture, the gains were concentrated among industrial metals and energy.
Several hurdles need to be successfully cleared for this performance to carry on into 2017. Donald Trump will become US president on January 20, and the market will keep a watchful eye on how he plans to revitalise US growth. While Trump could be successful in presenting growth-friendly policies, the risk of a trade war, especially with China, carries the risk of hurting global growth and demand for commodities.
When it comes to gauging the outlook for commodity demand, China will get a lot of attention, as usual. The rising battle against pollution, which back in December seemed to run out of control in northern China, combined with currency and liquidity fears has the potential to reduce growth and subsequent demand growth, especially for industrial metals.
The energy sector will be subject to a split focus. The US natural gas market will be driven by the severity of the US winter and subsequent demand for gas. The oil market, meanwhile, will be focusing on the ability of Opec and non-Opec producers to deliver the promised production cuts while also keeping an eye on production levels from countries not bound by the November agreement, especially Libya, Nigeria and the US.
The biggest risk to oil during the first quarter comes from potential long liquidation following a rapid build-up in bullish oil futures bets to a record during December.
Into 2017, crude oil will seek to further capitalise on the prospect that the market will finally rebalance as supply is lowered to meet demand. This is based on the assumption that Opec and non-Opec producers will deliver the promised and required cuts necessary to balance the market.
Nothing is ever simple, especially when it comes to the oil market. While the first quarter of 2017 is likely to see Brent crude stay above $50/barrel, the market will increasingly turn its attention to whether the production cuts will be delivered.
Considering Opec’s poor history in complying with its stated production targets, the potential for rising production from Libya and Nigeria, and US shale oil producers’ likely collective response, we could see the upward trajectory of higher lows and peaks challenged on several occasions.
That could happen perhaps already during the first quarter, not least considering the near 900-million-barrel combined long position in WTI and Brent crude oil. A position of this record size needs low volatility and compliance to be maintained. Any failure on either of those requirements could trigger a rapid rewind during which oil could slump by between $5 and $10.
We do expect, however, that both Opec and non-Opec producers will cut output, but not by the agreed amounts. This is likely to delay the rebalancing process, thereby creating the risk of price corrections later in the year.
Outside market developments are also going to play varying roles in setting oil’s price. Donald Trump won the US presidential election on a platform that promised tax cuts and increased infrastructure spending to boost the economy. These pledges have so far led to a stronger dollar while triggering a major rotation out of bonds as US inflation risks have been repriced.
The risk of protectionism, a stronger dollar, and rising cost of financing could potentially spell trouble for some emerging-market economies, thereby weighing on oil demand. Against this comes the risk of sanctions against Iran being re-introduced, so the oil market is likely to offer another year of major market movements.
With all of these considerations taken into account, we see the average price of Brent crude oil rising to $54/b in 2017 from $45/b in 2016. The highest price of the year (around $60/b) is likely to be seen during the second quarter after which time rising US production and a non-extension of Opec’s production cuts would see the market settle into a range.
Gold returned to profit for the first time in four years in 2016. But with the year distinctly cut into two halves, the outlook at the beginning of 2017 is a copy of the negative sentiment towards precious metals seen at the beginning of 2016.
An incoming US administration promising growth-friendly policies triggered a major rotation out of bonds into stocks during the final quarter of 2016. The outlook for several rate hikes from the US Federal Reserve combined with rising bond yields, the stronger dollar and higher stock prices all helped change the outlook for gold, and it drove a major exodus out of “paper” investments.
Hedge funds cut a record-long gold futures position by 85%, while investors in exchange-traded products pulled 225 tons out of the 600 tons that was bought during the first 10 months of 2016.
The dollar’s trajectory, especially against EUR and JPY, remains clouded, but with a potential dollar high in sight, we see limited further headwind from a rising greenback. While we wait to see whether hopes can be replaced with action by the new US administration, the rapid rise in bond yields following the US November presidential election may also have run its course for now. Combining this with rising inflation expectations, we should see relative subdued real yields.
High inverse correlation between gold and the dollar and US real yields created a great deal of headwind during final months of 2016.
While a Trump presidency initially has been perceived as negative for investment metals, we see several risks ahead which could change this impression. The rising populist vote, which gave us Brexit and Trump, will increase uncertainty ahead of key elections in Germany, France and the Netherlands. In the US, the risk of a trade war, especially with China, and a foreign policy carried out via Twitter could also create demand for safe-haven assets.
Gold’s failure to break the 2011 downtrend on several occasions last year has left the metal in search of support. It found some at $1,125/oz after correcting 76.4% of the December 2015 to July 2016 rally. We see gold challenged at the beginning of 2017, but as some of the strong negative drivers begin to fade, a base is likely to be established during the first quarter.
We see gold range-bound in Q1 between $1,100 and $1,200/oz, with a year-end forecast at $1,325/oz.
Industrial metals led the commodity revival in late 2016 on strong China demand and post-Trump hopes of a pick-up in US growth and subsequent demand. Having traded sideways for more than a year, copper jumped almost 15% in November and December. The election of Trump and his pledge to boost infrastructure spending massively helped trigger a major surge in speculative demand on futures exchanges in New York, London and Shanghai.
On the fundamental front, we see a year where supply growth is likely to be subdued, which leaves the market supported as long as China is able to keep up its still strong demand for copper. That, however, may be called into question after China back in December signalled a willingness to allow weaker growth to bring its finances under control.
Trump is unlikely to deliver a boost to demand strong enough to justify the recent surge in copper prices. Even if his infrastructure pledge is carried out, it may not take hold before the next US financial year which commences on October 1, and it would then be spread out over several years. Adding to this the risk to EM demand from the danger of trade wars and protectionism, we see limited upside to copper beyond the 2016 high at $2.75/lb on high-grade copper, and we see a risk of the metal correcting back towards $2.25/lb.
