Commodity Weekly: Gold down, Oil up on Recovery Hopes

What is our trading focus?

  • OILUKJUL20 – Brent Crude Oil (July)
  • OILUSJUL20 – WTI Crude Oil (July)
  • NATGASUSJUN20 – Natural Gas
  • XAUUSD – Spot gold
  • XAGUSD – Spot silver
  • COPPERUSJUL20 – HG Copper
  • CCN0 – Cocoa (July)

The world, at least on paper, suddenly looked in a better place this past week with several pieces of Covid-19 related news spurring a recovery. Key commodities such as crude oil and gasoline found a bid following the recent collapse and mayhem while gold, the safe-haven metal, headed for its largest weekly decline in seven weeks.

Driving the change in sentiment was the first glimmer of light at the end of the very long coronavirus tunnel. This, after several European countries began preparations for partial re-openings together with the prospect or hope for a Covid-19 treatment drug emerging.

These developments did at least temporarily reduce to focus on the steep rise in global unemployment and collapsing consumer confidence. They also increase the talk in the market that a V-shaped recovery would begin to emerge, thereby reducing the fallout from what has become the worst collapse the world has seen since the Great Depression.

We view the road to recovery unfortunately as being anything but V-shaped. While the short-term technical outlook for gold has deteriorated, the long-term fundamentals have not. On that basis we remain positive about the medium to long-term outlook for gold but also accept that the current drivers are evenly matched in terms of head and tailwind. We see the current and future price development being impacted by these risks:

Hedge against central monetization of the financial market;
Yield curve control to push real yields – a key driver for gold – lower;
A rising global savings glut at a time of very low and negative interest rates;
DM investment demand off-setting weak EM consumer demand (China and India);
Rising geo-political risks as the Covid-19 blame game begins (China vs rest of world).

Easing lockdowns and a potential treatment drug;
V-shaped recovery hopes driving Wall Street further away from Main Street (rising unemployment and collapsing consumer confidence);
Plummeting jewelry demand in China and India;
Risk of central banks selling gold as budget deficits rise and currencies weaken.

Despite record-high demand for bullion-backed ETF’s, gold continues to find resistance ahead of $1750/oz. The lack of price momentum has already seen hedge funds begin to cut bullish gold bets. In the week to April 21, the net-long held by speculators dropped to a near ten-months low following a 37% reduction since February. Silver’s lack of performance, due to its industrial link, has led to an exodus from speculative investors. In the latest reporting week to April 21 the net long was cut to just 13,500 lots, down by 80% since the February peak.

Silver’s ratio to gold, which remains stuck at a multi-decade high above 110 ounces of silver to one ounce of gold, is likely to remain stuck with the short-term risk of moving even higher. This in response to weaker global growth as it reduces demand towards industrial applications. However, a renewed rally in gold together with the mentioned small net-long could provide some support from investors looking at its relative cheapness as an investment substitute to gold.

Hedge funds, or CTA’s as some are also called, execute their models often not based on fundamentals but rather on technical and price-based signals. They tend to increase position size once they have established a profitable position (buying into strength while selling into weakness) until a market reversal happens. While the gold market, in our opinion, is nowhere near a reversal, the current lack of momentum has driven long liquidation from this type of funds.

With this in mind we may see the short-term outlook being challenged with the risk of a deeper correction towards $1655/oz and perhaps even $1634/oz before the above-mentioned upside risks begin to reassert themselves again.

Crude oil spent the week trying to recover from the recent carnage which sent the now expired May WTI futures contract deep into negative territory. In order to avoid a repeat ahead of the July contract expiry on May 19, several changes have been introduced. The CME have raised the margin for holding a position while also capping limits on positions being held by futures tracking ETF’s. Major commodity funds, such as the S&P GSCI, have already rolled exposure further out the curve, while several banks and brokers have introduced ‘reduce only’ rules on positions being held by its customers in the June contract.

The two fundamental drivers behind the first weekly gain in a month were the prospect of a pickup in demand as countries begin to exit lockdowns and a rush from producers, both OPEC+ and others, to cut production in order to avoid forced shut-ins from lack of storage facilities.

If the world runs out of facilities to store unwanted crude oil, production needs to equal demand. That can only be achieved by a major cut in production, not necessarily from the high-cost producers, but primarily from those not having a buyer for their oil. Norwegian-based Rystad Energy in their latest report said they expect demand to drop by 28 million barrels per day this month; by 21 million next month; and by 16 million in June. Goldman Sachs in another report saw global storage facilities filling up within the next month.

While prices used to settle physical transactions remain weak, we have seen speculative demand drive futures prices higher this past week. The saga of the under pressure USO oil ETF has not gone away but having been forced by regulators to roll their exposure further out the curve, the systemic risk of the ETF failing has eased.

The lack of performance associated with this move away from the most volatile front month has finally, but unfortunately too late for many novice investors, begun to reduce demand. An example being a US-based trading platform which during the past month, when the ETF halved in value, saw the number of clients holding USO positions almost rise by a factor 10 before being cut by more than one-third in just one day on Thursday.

As mentioned, crude oil was heading for its first weekly gain in a month in response to production cuts being announced by others than just OPEC+ and on signs that the coronavirus-driven plunge in demand has started to bottom out. Resistance at $23.5/b on WTI and $28/b on Brent could, however, cap the upside for now. The short-term outlook remains challenging as storage tanks continue to fill. The race to avoid tank tops and with that the risk of forced shut-ins remains a key risk and the futures market could be at risk of rising to levels not yet supported by developments in the cash market.

Commodities on the move:

Natural gas futures rose to $2/MMBtu for the first time since February as the prospect of lower output from associated shale oil production helped lift the price. Bloomberg reported that gas production in lower 48 US states fell to 85.6 bcf/d to the lowest since July and down 10% from the record levels reached last December.

RBOB Gasoline jumped to a six-week high after the EIA reported a the first drop in stocks in five weeks and after US consumption recorded its third straight gain to 5.86 million barrels/day, still some 35% below the one-year average.

HG Copper traded lower on the week after once again finding resistance at $2.38/lb, the 618% retracement of the February to March sell-off. Ample stocks, the return of shut in production and the increased risk of a deep recession hurting demand the main focus and one that is likely to keep prices sideways to lower in over the coming weeks.

Livestock prices led by hogs rose sharply as a US meat crisis began to unfold. This after sixteen major poultry, pork and beef processing pants closed after they became Covid-19 hotbeds. Pork production has been the hardest hit with nearly half of all processing currently offline. After touching an 18-year low two weeks ago Lean hog futures have since jumped by 60%.

Cocoa continued to show signs of recovering after breaking back above $2400/MT. Risk to demand from the covid-19 outbreak sent prices tumbling by 25% before stabilizing and now moving higher. Apart from the improved technical outlook, bad weather and stay away workers worried about getting the virus could hurt production in West Africa, the top growing region.

Ole Hansen, Head of Commodity Strategy at Saxo Bank.
This article is provided by Saxo Capital Markets (Australia) Pty. Ltd, part of Saxo Bank Group through RSS feeds on FX Empir

What are Contango And Backwardation?

Term structure, the forward curve, or time spreads are all synonymous and reflect the price differences for a commodity over time.

In some commodities, seasonality causes prices to reach lows at certain times of the year and peaks at others. Natural gas and heating oil often reach seasonal highs during the winter months, while gasoline, grains, lumber, and animal proteins can move towards highs as the spring and summer seasons approach.

Meanwhile, the price differential for various delivery dates can provide valuable information when it comes to the supply and demand fundamentals for all commodities. Contango and backwardation are two essential terms in a commodity trader’s vocabulary.

Contango is a sign of a balanced or glut market

Contango exists in a market when deferred prices are higher than prices for nearby delivery. A “positive carry” or “normal” market is synonymous with contango.


The forward curve in the NYMEX WTI crude oil futures market highlights the contango in the energy commodity. In this example, the price of crude oil for delivery in June 2020 was at $28.82 per barrel and was at $36.10 per barrel for delivery one year later in June 2021. The contango in the oil market stood at $7.28 per barrel.

The contango is a sign of oversupply. However, it also reflects the market’s opinion that the current price level will lead to declining production and inventories and higher prices in the future.

Backwardation signals tightness

Backwardation is a market condition in which prices are lower for deferred delivery compared to nearby prices. Other terms of backwardation are “negative carry” or “premium” market.

Source: ICE/RMB

The term structure in the cocoa futures market that trades on the Intercontinental Exchange shows that cocoa beans for delivery in May 2020 were trading at $2305 per ton compared to a price of $2265 for delivery in May 2021. The backwardation of $40 per ton is a sign of nearby tightness where demand exceeds available supplies. At the same time, the lower deferred price assumes that cocoa producers will increase output to close the gap between demand and supplies in the future.

Watch the forward curve

A fundamental approach to analyzing commodity prices involves compiling data on supplies, demand, and inventories. The term structure in raw material markets can serve as a real-time indicator for supply and demand characteristics. When nearby supplies rise above demand, the forward curve tends to move into contango. When the demand outstrips supplies, backwardations occur.

Watching the movements in term structure can provide value clues when it comes to fundamental shifts in markets. Exchanges publish settlement prices for all contracts each business day. Keeping track of the changes over time can uncover changes that will impact prices.

In tight markets where backwardations develop or are widening, nearby prices tend to move to the upside. In contango markets, equilibrium can be a sign of price stability, while a widening contango often is a clue that prices will trend towards the downside.

The shape of the forward curve can move throughout the trading day. Any dramatic shifts tend to signal a sudden change in market fundamentals. For example, a weather event in an agricultural market that impacts production would likely cause tightening and a move towards backwardation. As concerns over nearby supplies rise, the curve often tightens.

Conversely, a demand shock that leads to growing inventories often leads to a loosening of the term structure where contango rises. Observing changes in a market’s forward curve and explaining the reasons can provide traders and investors with an edge when it comes to the path of least resistance of prices.

Are Cocoa Prices Going Higher?

If you are long a futures contract I would place the stop loss under yesterday’s low of 2594 as an exit strategy as the chart structure is outstanding at the current time, however for the bullish momentum to continue prices have to break November 18th high of 2694 in my opinion. Last Friday’s Commitment of Traders data (COT) showed that funds boosted their long cocoa positions by 15,528 contracts in the week ended Nov 19th to a 5-year high of 60,818 contracts which could provide fuel for long liquidation pressure.

Fundamentally speaking reduced output from Ghana, the world’s 2nd largest cocoa producer is supportive for cocoa prices after the Ghana Cocoa Board on Sep 13th cut its Ghana 2019/20 cocoa production estimate to a 3-year low of 800,000 MT from a previous estimate of 950,000 due to an outbreak of the swollen shoot cocoa disease that has affected about 16% of Ghana’s cocoa crop.




This article was written by Michael Seery (CTA—COMMODITY TRADING ADVISOR)