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A moment in markets – Dollar weakness bodes well for commodities

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WisdomTree
WisdomTree

The US dollar has been meaningfully weak this year with most of the depreciation occurring since June. The dollar index spot rate – measured as the average exchange rate between the dollar and major world currencies – fell by over 8% between 15 May and 31 August (see figure 01 below). The US dollar is typically seen as a safe-haven asset during times of financial market volatility and economic uncertainty. This year, however, it has failed to live up to that reputation.

In March, when the pandemic first tightened its grip on markets, the dollar rose sharply but was unable to sustain its gains for long. In September again, as second wave fears and US election uncertainty paired up to create volatility in stock markets, dollar initiated a rebound. It appears to have lost steam even more quickly this time around though.

Strengh in commodities
Source: WisdomTree, Bloomberg. Data from 01 Jan 2020 to 04 Oct 2020. US dollar is represented by DXY Index (dollar index spot rate) and Broad Commodities is represented by Bloomberg Commodities Index.

Weaker for longer?

What else can dollar bulls count on if haven demand fails to materialize despite the challenges facing markets and the economy?  Currency strength is relative and weakness in other major currencies including sterling and euro could help revive the dollar. Euro and sterling may fall if Brexit uncertainty and disruption hurt the economic prospects for both Europe and the UK. This would need to be supplemented by continuously improving economic data in the US.

Dollar bears would point to short-term risks facing the economic recovery including second wave virus risks as well as election uncertainty. If the conversation veers towards longer term prospects, they may end up throwing a knockout punch by highlighting the Federal Reserve’s lower for longer policy. In the end, ultra-loose monetary policy for a protracted period is bound to put pressure on the currency.

Physical gold and silver
Source: WisdomTree, Bloomberg. Data from 28 April 2006 to 04 October 2020.

Commodity investors aren’t complaining

Dollar weakness has helped fuel the recovery rally in broad commodities – albeit supporting different commodity sectors in different ways and to varying degrees. There are two key reasons why dollar weakness supported commodities – notably since June – and why continued weakness in the greenback could be good news for commodity investors:

  1. The haven effect: With the dollar being weak, investors have turned to alternative safe havens as better ‘stores of wealth’. Gold and silver have benefitted the most from this ‘haven effect’. Dollar’s strength and gold’s weakness were both short-lived in March. Investors have turned to physical precious metals knowing that, with their finite supply, they cannot be devalued like fiat currencies by policymakers in response to crises (see figure 02 above).
  2. The purchasing power effect: Cyclical commodities also benefit from dollar weakness as holders of other currencies find it cheaper to buy dollar-denominated commodities. Both industrial metals and agricultural commodities stand to benefit from this effect.
Dollar weakness
Source: WisdomTree, Bloomberg. Data from 01 Jan 2017 to 31 Dec 2018. US dollar is represented by DXY Index (dollar index spot rate) and Broad Commodities is represented by Bloomberg Commodities Index.

There is, however, a catch…Trade wars

The dollar depreciated considerably in 2017 and start of 2018 which lent support to broad commodities (see figure 03 above). Arguably, among the reasons for the erosion in the currency’s value was an increase in protectionist rhetoric from President Trump. The possibility of the US isolating itself rather than being an integral force in the global economic machine hurt the dollar back then. The reason why commodities could not sustain a lasting rally was because the protectionist rhetoric eventually culminated in a trade dispute between the US and China with tariffs directly imposed on several commodities. While gold benefitted as a geopolitical hedge, cyclical commodities including industrial metals and agriculturals suffered. The catch, therefore, is that for broad commodities to make lasting gains from a weak dollar, the weakness in the currency must stem from accommodative monetary policy rather than an acceleration in trade wars. If trade tensions escalate again, defensive commodities like precious metals will be expected to extend their gains over cyclical sectors.

Mobeen Tahir, Associate Director, Research, WisdomTree

Analys

Crude stocks fall again – diesel tightness persists

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SEB - analysbrev på råvaror

U.S. commercial crude inventories posted another draw last week, falling by 2.4 million barrels to 418.3 million barrels, according to the latest DOE report. Inventories are now 6% below the five-year seasonal average, underlining a persistently tight supply picture as we move into the post-peak demand season.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

While the draw was smaller than last week’s 6 million barrel decline, the trend remains consistent with seasonal patterns. Current inventories are still well below the 2015–2022 average of around 449 million barrels.

Gasoline inventories dropped by 1.2 million barrels and are now close to the five-year average. The breakdown showed a modest increase in finished gasoline offset by a decline in blending components – hinting at steady end-user demand.

Diesel inventories saw yet another sharp move, falling by 1.8 million barrels. Stocks are now 15% below the five-year average, pointing to sustained tightness in middle distillates. In fact, diesel remains the most undersupplied segment, with current inventory levels at the very low end of the historical range (see page 3 attached).

Total commercial petroleum inventories – including crude and products but excluding the SPR – fell by 4.4 million barrels on the week, bringing total inventories to approximately 1,259 million barrels. Despite rising refinery utilization at 94.6%, the broader inventory complex remains structurally tight.

On the demand side, the DOE’s ‘products supplied’ metric – a proxy for implied consumption – stayed strong. Total product demand averaged 21.2 million barrels per day over the last four weeks, up 2.5% YoY. Diesel and jet fuel were the standouts, up 7.7% and 1.7%, respectively, while gasoline demand softened slightly, down 1.1% YoY. The figures reflect a still-solid late-summer demand environment, particularly in industrial and freight-related sectors.

US DOE Inventories
US Crude inventories
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Analys

Increasing risk that OPEC+ will unwind the last 1.65 mb/d of cuts when they meet on 7 September

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SEB - analysbrev på råvaror

Pushed higher by falling US inventories and positive Jackson Hall signals. Brent crude traded up 2.9% last week to a close of $67.73/b. It traded between $65.3/b and $68.0/b with the low early in the week and the high on Friday. US oil inventory draws together with positive signals from Powel at Jackson Hall signaling that rate cuts are highly likely helped to drive both oil and equities higher.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Ticking higher for a fourth day in a row. Bank holiday in the UK calls for muted European session. Brent crude is inching 0.2% higher this morning to $67.9/b which if it holds will be the fourth trading day in a row with gains. Price action in the European session will likely be quite muted due to bank holiday in the UK today.

OPEC+ is lifting production but we keep waiting for the surplus to show up. The rapid unwinding of voluntary cuts by OPEC+ has placed the market in a waiting position. Waiting for the surplus to emerge and materialize. Waiting for OECD stocks to rise rapidly and visibly. Waiting for US crude and product stocks to rise. Waiting for crude oil forward curves to bend into proper contango. Waiting for increasing supply of medium sour crude from OPEC+ to push sour cracks lower and to push Mid-East sour crudes to increasing discounts to light sweet Brent crude. In anticipation of this the market has traded Brent and WTI crude benchmarks up to $10/b lower than what solely looking at present OECD inventories, US inventories and front-end backwardation would have warranted.

Quite a few pockets of strength. Dubai sour crude is trading at a premium to Brent  crude! The front-end of the crude oil curves are still in backwardation. High sulfur fuel oil in ARA has weakened from parity with Brent crude in May, but is still only trading at a discount of $5.6/b to Brent versus a more normal discount of $10/b. ARA middle distillates are trading at a premium of $25/b versus Brent crude versus a more normal $15-20/b. US crude stocks are at the lowest seasonal level since 2018. And lastly, the Dubai sour crude marker is trading a premium to Brent crude (light sweet crude in Europe) as highlighted by Bloomberg this morning. Dubai is normally at a discount to Brent. With more medium sour crude from OPEC+ in general and the Middle East specifically, the widespread and natural expectation has been that Dubai should trade at an increasing discount to Brent. the opposite has happened. Dubai traded at a discount of $2.3/b to Brent in early June. Dubai has since then been on a steady strengthening path versus Brent crude and Dubai is today trading at a premium of $1.3/b. Quite unusual in general but especially so now that OPEC+ is supposed to produce more.

This makes the upcoming OPEC+ meeting on 7 September even more of a thrill. At stake is the next and last layer of 1.65 mb/d of voluntary cuts to unwind. The market described above shows pockets of strength blinking here and there. This clearly increases the chance that OPEC+ decides to unwind the remaining 1.65 mb/d of voluntary cuts when they meet on 7 September to discuss production in October. Though maybe they split it over two or three months of unwind. After that the group can start again with a clean slate and discuss OPEC+ wide cuts rather than voluntary cuts by a sub-group. That paves the way for OPEC+ wide cuts into Q1-26 where a large surplus is projected unless the group kicks in with cuts.

The Dubai medium sour crude oil marker usually trades at a discount to Brent crude. More oil from the Middle East as they unwind cuts should make that discount to Brent crude even more pronounced. Dubai has instead traded steadily stronger versus Brent since late May.

The Dubai medium sour crude oil marker
Source: SEB graph, calculations and highlights. Bloomberg data

The Brent crude oil forward curve (latest in white) keeps stuck in backwardation at the front end of the curve. I.e. it is still a tight crude oil market at present. The smile-effect is the market anticipation of surplus down the road.

The Brent crude oil forward curve (latest in white)
Source: Bloomberg
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Analys

Brent edges higher as India–Russia oil trade draws U.S. ire and Powell takes the stage at Jackson Hole

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SEB - analysbrev på råvaror

Best price since early August. Brent crude gained 1.2% yesterday to settle at USD 67.67/b, the highest close since early August and the second day of gains. Prices traded to an intraday low of USD 66.74/b before closing up on the day. This morning Brent is ticking slightly higher at USD 67.76/b as the market steadies ahead of Fed Chair Jerome Powell’s Jackson Hole speech later today.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

No Russia/Ukraine peace in sight and India getting heat from US over imports of Russian oil. Yesterday’s price action was driven by renewed geopolitical tension and steady underlying demand. Stalled ceasefire talks between Russia and Ukraine helped maintain a modest risk premium, while the spotlight turned to India’s continued imports of Russian crude. Trump sharply criticized New Delhi’s purchases, threatening higher tariffs and possible sanctions. His administration has already announced tariff hikes on Indian goods from 25% to 50% later this month. India has pushed back, defending its right to diversify crude sourcing and highlighting that it also buys oil from the U.S. Moscow meanwhile reaffirmed its commitment to supply India, deepening the impression that global energy flows are becoming increasingly politicized.

Holding steady this morning awaiting Powell’s address at Jackson Hall. This morning the main market focus is Powell’s address at Jackson Hole. It is set to be the key event for markets today, with traders parsing every word for signals on the Fed’s policy path. A September rate cut is still the base case but the odds have slipped from almost certainty earlier this month to around three-quarters. Sticky inflation data have tempered expectations, raising the stakes for Powell to strike the right balance between growth concerns and inflation risks. His tone will shape global risk sentiment into the weekend and will be closely watched for implications on the oil demand outlook.

For now, oil is holding steady with geopolitical frictions lending support and macro uncertainty keeping gains in check.

Oil market is starting to think and worry about next OPEC+ meeting on 7 September. While still a good two weeks to go, the next OPEC+ meeting on 7 September will be crucial for the oil market. After approving hefty production hikes in August and September, the question is now whether the group will also unwind the remaining 1.65 million bpd of voluntary cuts. Thereby completing the full phase-out of voluntary reductions well ahead of schedule. The decision will test OPEC+’s balancing act between volume-driven influence and price stability. The gathering on 7 September may give the clearest signal yet of whether the group will pause, pivot, or press ahead.

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