Industrial metal basket ETP flows benefited the most as trade wars intensify
ETF Securities Weekly Flows Analysis – Industrial metal basket ETP flows benefited the most as trade wars intensify
Highlight
Industrial metal basket ETP took the lion’s share of inflows surging the most since December 2017
Gold ETPs suffered outflows last week after hawkish comments by the Federal Reserve
Bargain hunters appear to drive inflows into crude oil ETPs ahead of the OPEC meeting on June 22
Industrial metal basket ETPs took the lion’s share of inflows, worth US$52.8mn extending last week’s trend of positive inflows. Caught in the cross fire of geopolitical trade wars, industrial metals as a group declined by 3.77% last week. Industrial metal prices also faced headwinds from weak Chinese economic data. Fixed asset investments grew by only 6.1% while industrial production grew by 6.8% in May according to National Bureau of Statistics (NBS). Bargain hunters appeared to take advantage of the price weakness as industrial metal basket ETP flows surged the most since December 2017.
In retaliation to the US tariffs, China’s Finance Ministry has imposed an additional 25% tariff effective on July 6 on a list of 545 product categories , covering nearly US$34bn in exports from the US. The list includes automobiles and agricultural products that might have an effect on manufacturers. Most metal markets continue to remain in deficit and we expect the current trade tariff’s to continue to generate considerable uncertainty within the supply chain.
Gold ETP outflows surged by US$41.4mn, reversing the prior two week’s trend of inflows after hawkish comments by the Federal Reserve . The stronger US dollar coupled with a more hawkish Federal Reserve, underpinned the weakness in gold prices that were declined 1.81% last week. Geopolitical risks that were previously supporting gold prices faded as the divergent interest rate policy projections at the key central bank meetings last week took centre stage. While the Federal Open Market Committee (FOMC) delivered another quarter point rate hike in the Federal Funds rate, this was largely priced in by markets. However the Fed’s forward guidance on its interest rate trajectory took the markets by surprise.
The Fed’s dot plot moved higher marginally in favour of two additional rate hikes this year, so four in total. Interestingly, it also anticipated a further three rate hikes of 25Bps in 2019 as the US economic outlook remains positive. Gold, that does not yield any interest came under significant pressure from the Fed’s more subdued outlook on inflation. The spread between the US 2 and 10-year yields declined to 38Bps its lowest level since 2007 reflecting the markets conviction in near term growth projections versus the future. In sharp contrast a day later, the European Central Bank (ECB) President Mario Draghi provided a more dovish forward guidance with no change in interest rates until the summer of 2019. The ECB remains far from normalizing policy, this lent further buoyancy to the US dollar as the Euro declined sharply adding further pressure on gold prices.
Crude oil ETPs received US$9mn of inflows last week reversing the trend of outflows witnessed over the last nine consecutive weeks. Oil prices are being dominated by rumours surrounding production cuts to be announced at the OPEC meeting in Vienna next week on June 22. Saudi Arabia is expected to raise production gradually however Venezuela and Iraq are not in favour of raising production according to sources close of OPEC.
European equity ETPs witnessed outflows worth US$9mn for the third week in a row. Dovish signals from the ECB helped European equities recover 1.04% last week. Profit taking appears to have driven outflows from European equity ETPs. The Euro slipped 1.35% versus the US dollar last week, helping European equities recover, as nearly 50% of revenues on European indices are generated internationally.
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The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
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Commodity recovery to continue although geopolitics acts as source of volatility
Commodities Research – Commodity recovery to continue although geopolitics acts as source of volatility
Highlights
Industrial metals likely to lead commodity performance in 2018 on the back of tight supply and demand continuing to rise.
Monetary conditions likely to weigh on gold although geopolitical risks are holding prices up for now.
Planned production curbs and geopolitics currently keeping oil prices high; US production likely to expand.
Commodities are in a third year of a recovery, after a five year slump. Being largely a cyclical asset class, commodities have traced the economic recovery that has gathered momentum in recent years. Global manufacturing purchasing managers indices hit a seven year high earlier this year, indicating that manufacturing order books are strong and inventories are lean, boding well for commodity-intensive demand from the industrial sector. In recent weeks the threat of a trade war has dented otherwise strong performance and we believe that as long as the threat subsides, fundamentals will supersede and allow commodities to continue to recover. For certain commodities like aluminium and oil, the threat of supply disruptions from sanctions could lead to higher prices as long as demand is not hampered by the economic uncertainty that trade wars and sanctions breed.
Asset Class Performance Ranked – 2007-2018
Source: ETF Securities, Bloomberg
Data until April 30, 2018; All returns are in USD; YTD returns are from 29 Dec 17 to 30 Apr 18; 10 Yrs returns are annualised from 29 Dec 07 to 29 Dec 17.
Data: Equity – MSCI World, Bond – Bloomberg Barclays Agg Sovereign TR Unhedged, Real Estate – EPRA/NAREIT Global, Commodity – Bloomberg All Commodities, Cash – US T-Bill 3 Mth
Historical performance is not an indication of future performance and any investments may go down in value
As highlighted below, commodities are not a homogenous, unified asset class and the performance of each subsector can be vastly different. We expect differentiated performance during 2018. Industrial metals are likely to continue to take a lead (leveraging off their cyclical nature). Meanwhile a rising interest rate environment is likely to place downward pressure on gold prices, although the metal is likely to benefit from its potential role as a haven asset. With oil prices likely to have topped out, energy prices are likely to be a drag on the wider commodity complex, if the geopolitical premium currently present dissipates. Agriculture is somewhat difficult to assess until the crop is in the ground, but based on what’s in progress, damage to the US winter wheat and West African cocoa crop could be countered by a strong rebound in sugar and coffee production, leaving that segment broadly flat.
Commodity Sector Performance Ranked – 2007-2018
Source: ETF Securities, Bloomberg Data until April 30, 2018; All returns are in USD; YTD returns are from 29 Dec 17 to 30 Apr 18; Data: Proxies for each commodity sector using Bloomberg sub-sector indices TR
Historical performance is not an indication of future performance and any investments may go down in value
Industrial metals
Most industrial metals are in a supply deficit (i.e. demand is greater than supply). Demand remains strong in an environment of economic growth, while supply has been constrained after a dearth of capital spending by miners. It is unlikely that supply will surge in the near term give the lags between project sanction and completion. Recovering miner margins are likely to see several metals come to a production balance in a couple of years, but for now the market remains tight.
Coppersupply was constrained last year as the world’s top two producers Escondida in Chile and Grasberg in Indonesia underwent supply disruptions. The root causes of these disruptions have not been fully resolved. Workers at Escondida went on strike for 44 days as they were unhappy with wage negotiations. Instead of agreeing on a wage that would be palatable, Escondida used an obscure law to extend the current contract to this year. That contract expires in July 2018. Early wage negotiations have started, but there is no guarantee that an amicable outcome will be reached without further outages.
Production at Grasberg paused due to an impasse between the majority owner of the mine, Freeport McMoran Inc and the Indonesian Government who insisted that they divest 51% of their holdings of the local mine. While an agreement has been reached, the deal still needs to be financed, and it is not clear at what price. Either way, Freeport is unlikely to invest significant amounts in this mine, given its recent experience with ownership rights. With the open pit part of the mine likely to be exhausted in coming years, underground deposits will need to be developed. That will be difficult if investment is inadequate.
Alongside the strength in cyclical demand for nickel, structural changes in demand bode well for the metal. Nickel is used in battery technology, which is experiencing a boost in demand from the electric vehicle industry. In 2016, the stock of electric vehicles was around 2 million (0.2% of total stock). The International Energy Agency forecast that by 2020 there will be between 9 and 20 million electric vehicles and by 2025 there will be 40-70 million vehicles. The nickel-manganese-cobalt (NMC) cathode is the most popular cathode used in lithium-ion batteries.
The European Commission’s Joint Research Centre forecasts that NMC cathodes will grow more than other forms. By 2025, they expect NMC demand to rise from 40k tonnes in 2015 to 192k tonnes (a rise from 29% share to 48% share of the overall cathode active materials market for batteries).
Up until recently, the NMC cathode would use equal parts of nickel, manganese and cobalt, but the market is changing to a 8:1:1 ratio of the three metals (in favour of nickel). The reason for the transition is largely due to the relative scarcity of cobalt and potential supply disruptions to the metal. 60% of the world’s cobalt is mined out of the Democratic Republic of Congo (DRC), a country which lacks political and economic stability.
Although the threat of trade wars and sanctions have put into question the strength of potential demand for industrial metals and thus dented the performance of certain metals in recent weeks, the disruption to trade could equally tighten the supply of metal. That is already being played out in aluminium.
Precious metals
Gold has been a key beneficiary of the recent rise in geopolitical risk. Gold wears many hats. At times it is a monetary asset – an alternative currency to the US Dollar or Euro – whose value historically declines in periods of monetary tightening. Other times it can be seen as a safe-haven asset – the port of call for investors seeking refuge from the volatility that uncertainty breeds. Today gold is wearing that second hat. In fact for most of this year gold has been sporting its safe-haven hat. US government shutdowns, sabre-rattling between US/Japan and North Korea, the ratcheting up of a trade war between the world’s largest economies, interactions between Russia and NATO sponsors deteriorating back to cold-war tendencies, the potential return of sanctions against Iran and the proxy war between Saudi Arabia and Iran are few of the sources of investor anxiety. That’s all in the backdrop of cyclical assets experiencing periodic downward lurches after several years of serenity. In recent days the threat of military strikes in Syria have added to that anxiety.
In the absence of this second hat, we believe that gold would be trading much lower than the US$1309/oz level it was trading as of 01/05/2018 (Bloomberg). Interest rates in the US are rising, which will place downward pressure on gold prices, especially if the US is increasing rates faster than its counterparts in other countries (which could reverse the recent US Dollar weakness). In the absence of geopolitical risk, we believe that gold could decline to US$1275-US$1285/oz at the end of this year.
Energy
Oil prices have rebounded significantly from their 2016 lows of US$28/bbl. At close to US$74/bbl (01/05/2018, Bloomberg), oil prices are still far from their 2014 highs of US$115/bbl, and we believe are unlikely to reach that point in coming years. Indeed, oil is currently trading at the upper end of what we think is a viable trading range (in the absence of new supply shocks). For as much as the Organization of the Petroleum Exporting Countries (OPEC) has made progress in curbing production and reducing OECD inventories of oil, the high price environment will encourage further expansion of production from the United States. The US shale oil industry is price-sensitive and nimble. In contrast to traditional oil production which has multi-year lead times, the decision to switch on a rig in the US can lead to oil production within a matter of weeks. We expect US supply to continue to rise, which will keep a lid on prices. Meanwhile, we expect that OPEC will start to signal how it will taper its curbs on production down in 2019 at its June 2018 meeting. So there is likely to be downward pressure on prices.
However, for the time being there is a geopolitical premium on oil prices. Potential sanctions against Iran and Russia could tighten the market up more aggressively than is currently assumed. Obviously geopolitical risk can blow over as quickly as they flare up, which could remove the premium in oil. However, should the risks crystallise in actual sanctions, prices could trend higher.
Curve dynamics
When investing in commodities via futures contracts (or solutions tracking a futures contract), an investors is exposed to the price difference between an expiring contract and the new contract they roll into. Sometimes that works in the investors favour (i.e. when the new contract is cheaper than the expiring contract – referred to as backwardation) and sometimes that works against the investors (i.e. when the new contract is more expensive than the expiring contract – referred to as contango). For several years (between 2014 and 2017), the Brent futures curve was primarily in contango, which acted as a drag on performance for investors in Brent futures. A global excess supply of oil kept front month prices of oil lower than elsewhere on the futures curve. OPEC’s efforts to drain excess inventories of oil since 2017 have helped Brent oil futures move back into backwardation. Although we expect OPEC to slowly taper some of its curbs on production in 2019, we are unlikely to see a glut of inventory develop again. Therefore, unless demand suddenly declines (which we don’t expect), we are unlikely to see the Brent futures go back into contango this year and hence this source of drag on performance is likely to be mitigated.
Brent oil: front minus second month contract price
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The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
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ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
OPEC together with its non-OPEC partners today decided to extend their production curbs to the end of 2018. With only luke-warm support from Russia heading into the meeting, doubts had formed earlier in the week as to whether the cartel will be able to pull it off.
Oil pricesrallied today on the news, but we expect prices to retreat. At current prices, US production will continue to expand, placing downward pressure on both WTI and Brent benchmarks.
At the current pace of expansion in the US, the global supply deficit will be short-lived. We could get back to a production surplus by Q1 2018. Russia’s main concern is that propping up prices through the production curbs has allowed US production to rise with vigour. The US is simply taking market share at the cost of OPEC and it partner countries. That is why Russia was keen to open discussions about an exit strategy.
Inserted into the new agreement is an option to review the current deal in June 2018 in light of prevailing supply and demand conditions. This potentially weakens the deal and we believe will become a source of volatility as the market speculates whether the adjustments will end prematurely in June.
Nigeria and Libya have been pulled into the deal
Nigeriaand Libya have been pulled into the deal, capping their output at 2017 levels (although no actual figure has been announced). They had previously been exempt given the scale of lost production due to attack-related outages.
With Brent oil trading close to US$64/bbl, we believe that compliance levels could slip once again as it becomes tempting to produce that little bit more at higher prices. We believe markets will be disappointed with compliance levels in coming months after very restrained production in October.
Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
Gold saw minor outflows of US$12.6mn, following gold inflows over the previous 5 weeks totalling US$312mn. The previous weeks of inflows are on a par to inflows seen in February this year. The gold market has been wrestling with the fact that corporate confidence data (PMIs) has highlighted that developed world growth is at a cycle high, which typically dampens sentiment for gold. Conversely, geopolitical risks, including Catalonia and North Korea keep escalating. The threat of a December interest rate hike in the US and possible tighter monetary policy from the ECB and UK is also likely to put pressure on gold prices in the coming months, particularly as we continue to see better than expected corporate earnings. This does not mean that there is a significant downside risk to gold though, as investors are very aware of the bubble in bonds, alongside higher valuations in equities and therefore see gold as an insurance policy against a correction and geopolitical crises. Supporting this is data highlighting an outflow of US$2.6mn year-to-date from short gold ETFs.
Recent rising oil prices have led to outflows in 12 of the past 13 weeks, totalling US$381mn, with US$13mn withdrawn last week. The outflows suggest investors do not feel that the recent rise in oil prices is sustainable. News of falling inventories in the US, fears for production in Kurdistan, production constraints caused by recent hurricanes and the potential for an OPEC production freeze extension have pushed up prices to the upper levels of our expected range of US$60/bbl. We believe oil prices have reached a high due to the downwards price pressures, being a continued lack in production freeze compliance from OPEC, a significant pick up in oil production and exports from the US and the Iraq-Kurdistan conflict having little impact on oil production in the region.
Industrial metals saw inflows last week totalling US$13mn despite recent strong price performance. Seasonally, industrial precious metals tend to fall in October and November, we see any price weakness in the coming months as an opportunity to take advantage of the continued improving fundamentals of supply-side destruction, multi-year supply deficits and increasing autos demand.
We continue to see interest in Robotics with inflows last week totalling US$33mn, the largest weekly inflow since inception (October 2014). Inflows year-to-date now total US$467mn.
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Is the Canadian Dollar signalling an oil price bottom?
Is the Canadian Dollar signalling an oil price bottom? The Bank of Canada (BOC) raised rates for the first time in seven years this week, the second major central bank to do so after the Federal Reserve. The BOC indicated that its economy ‘is approaching full capacity’. As a result, the Canadian Dollar, the so-called Loonie, jumped to the highest level against the US Dollar in 13 months. A rising CAD could be signalling a bottom for oil prices.
Business investment in the energy sector in Canada is recovering from a ‘prolonged steep decline’, according to the BOC, and oil exports are expected to improve, particularly to the US. The BOC notes that ‘the past oil shock is largely complete’. Indeed, Canadian energy companies have once again begun to implement capital expenditure plans with a sense of ‘cautious optimism’. Such an economic environment suggests that producers have largely adjusted to the current lower price environment. Rising investment and optimism reflects a better outlook for demand and is a supportive price environment for oil.
the Loonie has had a very strong correlation with oil prices
Historically, the Loonie has had a very strong correlation with oil prices, but the direction of causation is unclear. However, since the end of 2016, this relationship has become more distinct, showing that moves in the CAD are leading the moves in oil prices, reflecting that the BOC is adjusting policy partly as a result of strengthening underlying demand conditions in the energy sector. Against a backdrop of rising global oil demand, we feel that such a relationship could be signalling that the latest jump in CAD be the precursor of an oil price rebound.
With the Canadian economy improving and the central bank reacting in a proactive manner with its monetary policy stance, the CAD could move higher in coming months. In turn, with oil prices nearing a natural floor – where demand (supported by lower prices) has the potential to offset continued elevated global production levels – higher prices could be the result of a more balanced oil market in the second half of 2017.
Is the Canadian Dollar signalling an oil price bottom?
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnold joined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
