By Ole S. Hansen

DUBAI — 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:

Upside:

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).

Downside:

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 $1,750/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 $1,655/oz and perhaps even $1,634/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.

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.

— The writer is head of commodity strategy at Saxo Bank