Crude oil now at risk of deeper correction

The commodity sector was trading close to unchanged for a second week. Weakness in energy and especially precious metals were offset by gains across the agriculture and industrial metal sectors.

Precious metals, including platinum and palladium, have been on the slide throughout May with the stronger dollar and renewed focus on rising US interest rates triggering a long overdue correction and profit taking.

The energy sector was mixed with natural gas falling on the back of a bigger than expected inventory rise. This was somewhat offset by another – albeit small – weekly gain for crude oil. Both WTI and Brent crude oil finally made it above $50/barrel but after finding limited interest to take them higher some profit taking and technical selling was seen.

The agriculture sector notched up some strong gains and has now rallied in six out of the past seven weeks. Flooding and crop quality concerns in Argentina has seen soymeal rally by more than 50% since early April. This has supported not only soybeans futures but also other crops such as corn. Sugar has reached the highest level since July 2014 and the break above 17 cents/lb helped reduce nervousness among funds who currently hold a record long exposure to the sweetener.

Industrial metals traded higher led by copper as it received a boost from strong US housing data and easing concerns about China. Short-covering also helped drive copper higher after funds had turned positions around from a net-long to a major short during the previous two weeks.

 

The roller coaster ride in iron ore continued as it slumped back below $50/tonne after hitting $70 just five weeks ago. A speculative bubble on the Shanghai Futures Exchange exploded in spectacular fashion back then. Rising supply from miners continuing to increase production is coming at a time where demand from Chinese steel producers slows.

Crude oil rally being challenged

Crude oil finally reached and managed to breach the psychological level of $50/b this week. That level had increasingly become a focal point among traders and one that combined with the multiple involuntary supply disruptions have been supporting the market during the past couple of weeks. So much that the normal strong negative correlation to the dollar had broken down with oil moving higher despite the headwind being created by a recovering dollar.

However once the level was broken the lack of follow-through buying on both WTI and Brent crude oil raised a few eyebrows and sellers quickly emerged. Signs that producers have stepped up hedging activity further out the curve has increased the “risk” that these higher prices could see oil production among high cost producers stabilise and potentially begin to come back.

So whether the rejection is signaling a near-term top in the market still remains to early to say. Bullish momentum in crude oil has been strong for several weeks now. Not least due to the fundamental support coming from multiple supply disruptions which has helped, at least temporarily, to balance the market.

Funds increased bullish bets on both crude oils by 75 million barrels during the week ending May 17. The combined long of 650 million barrels that these investor now own is not far from the record seen back in

April. This build up in speculative longs combined with technical observations turning negative, a stabilising US rig count and seasonally weak refinery margins carries the risk of triggering a deeper correction.

WTI crude oil has been trading higher within an ascending wedge but the rejection above $50 could open up for a technical correction. Such a move would initially take it down to the bottom of the wedge at $47 while a break could see the move extend to bottom of the uptrend from the February low, currently at $45.

Opec meeting likely to yield nothing

The 167th meeting of the Conference of the Petroleum Exporting Countries (Opec) in Vienna on June 5 will begin to attract some attention over the coming days. Considering the continued price rally since the failed Doha meeting this meeting has become increasingly irrelevant. No decision is expected to be taken as no decision is required.

The market focus has shifted away from Opec as it has done very little to support the price recovery apart from providing some verbal intervention. Instead we have seen multiple and major supply disruptions which undoubtedly have helped balance the market and helped drive the price higher than what was otherwise warranted at this stage of the recovery.

The best Opec can do is to sit down and talk oil instead of letting politics and regional differences get in the way. Saudi Arabia’s new oil minister is expected to repeat the hardline approach seen at the failed Doha meeting. How that will go down, especially with Iran, remains to be seen.

Rebuilding the cartel’s reputation should be a priority. Whether they succeed or not will determine the potential impact on the market.

Ole Hansen, commodity expert at Saxo Bank

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