Many of the factors that have supported the recent upward trend in commodities look transient. Demand fundamentals are still a particular cause for concern. Although markets are hopeful that China’s more expansionary monetary and fiscal policy will boost commodity demand, we doubt that it will be as supportive as in the past. Meanwhile, we continue to be very concerned by the weakness in US distillates demand, which remains in recessionary territory, despite continuing improvement in other US economic indicators.
Fundamental Flows
The pick-up in investor sentiment to commodities that we highlighted in prior reports, continues to gather momentum. Asset managers are now more positive on copper prices than they have been for four months and on crude oil for almost five months. The price of copper has continued to rally strongly, rising above its 100-day moving average last week for the first time since mid-2015, and the upward trend in oil prices has continued.
In addition to the factors we outlined previously (bargain hunting, softer USD and positive returns in several commodity sectors YTD), sentiment was further boosted over the past week by expectations that this week’s China National People’s Congress will confirm a shift to a slightly looser monetary policy and more proactive fiscal policy to support growth; also by some improved US economic data last week showing above consensus figures for employment, construction spending and manufacturing sentiment; and finally by the growing credibility being attached to OPEC’s ‘production freeze’ policy, with Russian President Vladimir Putin confirming it will participate, plus some substantial unplanned current outages curtailing oil supply in the short term.
In a potentially virtuous circle, higher oil prices are themselves contributing to better sentiment in financial markets, since they are calming concerns about growth, which the steep move lower earlier this year had ignited. None of these factors are likely to prove more than a temporary boost to price prospects. While I am confident neither oil or copper prices will test fresh lows again, I think the risks are high that the current rally may soon run out of steam. I would highlight three factors which may stall the current impulsive advance off the lows and provide the catalyst for premium entry points for a broader corrective phase to ensue.
- Optimism over China seems somewhat premature. China economists point out that any fiscal policy expansion this year is likely to be very moderate and will struggle to overcome the softening GDP growth trend due to the continued headwinds from capacity reduction, destocking, and deleveraging.
- US data improvement is relative, and the big picture is that many of the most important commodity-consuming sectors of the economy still look soft. The US Bureau of Transportation Statistics shows a 2% decline in its freight services index for the same month, the largest drop since 2009.
- OPEC’s production freeze policy is far from certain to succeed. The market is well aware that the countries that have so far signaled support for the policy are mostly producing at close to capacity. Although markets are skeptical that the freeze talks will have much positive impact on oil market balances, the prospect of bullish headlines in the run-up to a 20 March meeting, however, the big risk is that the meeting proves a disappointment and prices fall back sharply on any lack of further progress.
Technical & Trading Takeaway
From a trading perspective as anticipated, crude is retesting the former lows of the AB leg of the larger weekly ab=cd pattern highlighted in previous crude chart reviews. I expect price to pull back on the initial test of this level, if we are going to trade a larger corrective pattern I will be watching intraday reversal patterns at the previous highs 34.50 to set long positions targeting a test of the 42/43 level. As the price action develops I will update this post with more specific entry, stops and exit parameters.
From a technical and trading perspective the Aussie is positioned in a similar structure to crude. We have a potential base developing. As with the crude I am monitoring the price action looking for a base breakout and pullback to test former resistance as support, if this price pattern plays out I will be monitoring intraday reversal patterns at the .7300/50 area to position for a broader correction/reversal.
