“The crude oil rally has probably run as far it could at this stage. The rally was driven by a spectacular increase in investment demand for crude, both through ETF’s and futures. While US production and inventory levels look set to be reduced over the coming months the continued increase in production from key OPEC members such as Saudi Arabia and Iraq has ensured that the global supply glut is very slow to be reduced.
In the short term (next 3-6 months) I see an increased risk of a 10 dollar correction on the basis that fundamentals have failed to support the rally. US shale oil producers which have seen production costs collapse as the industry has become oversupplied with workers and equipment are gearing up for a resumption of production should the price of WTI crude approach 65 dollars (59 currently).
Longer term much depends on the level of economic growth and demand. The sharp sell-off in crude oil since last August only seem to have improved demand in the US while many of the major EM countries have so far not seen any significant pick-up. Refineries have seen very profitable margins for several months now and as a result they have maintained a strong demand for crude oil, not least in the US. If however demand for products fail to pick up we will only have succeeded in moving oil from one tank (crude) to another (gasoline).
Towards the end of the year WTI crude should recover back towards 65 USD but given the US shale industry’s ability to cut cost any recovery above this level will prove shortlived as shale production recovers unless a major geopolitical event erupts.
As for Gold, it continues to be range bound and the recent attempt to break above resistance in 1225 to 1235 area have so far failed. A rally in stocks, bonds and the dollar today, however have so far not triggered any major sell activity which could indicate some underlying strength. Hedge funds and money managers failed to see the latest move higher and as of last Tuesday held a net-long futures position close to the lowest level in 16 months. This level of light positioning has attracted some new buying but so far not enough to take it above resistance.
The market seems to be slowly changing its focus from deflation towards the potential for emerging inflation and this combined with record low core bond yields will continue to provide gold with support. In the short term however the uncertainty related to if and when the US will make its first strike on interest rates should keep the investment appetite muted and ensure that the price will hang onto 1200 for a while longer before moving higher later in the year.
By Ole Hansen, Head of Commodity Strategy, Saxo Bank