Oil slumps, gold bulls bet on Fed

Has oil rally run out of gas?

Crude prices got hit with a trifecta of bad news: The dollar continues to rally as many currency traders unwind their bearish bets, WTI crude’s nearest timespread snapped into a bearish contango structure, and as some states show a rise in COVID cases.

It looks like the bullish crude moves that stemmed from the Texas deep freeze and the reopening of the economy are now fully priced in.  Oil prices have been extremely bullish since November and now it seems that we could finally be entering a consolidation period.  Despite record growth for US money supply and firm commitment of no tightening from the Fed, the dollar refuses to break due to a better outlook when compared with the rest of the world, especially Europe.  A stronger dollar should start to weigh on commodities and that should prevent oil prices from rallying too much.

A bearish contango structure for WTI is not surprising many given the strong build over the past couple of weeks.  The crude demand outlook still remains the key for higher prices and if short-term risks continue to grow due to virus variants, oil prices could be in for modest 10% pullback.

Covid cases are rising in New Jersey and Michigan and if that trend spreads across the nation, that could really derail some of the accelerated reopening measures.  Vaccinations are still going well, but short-term risks remain elevated.

Gold

The gold market is clearly expecting the Fed to reaffirm their dovish commitment.  Treasury yields remain elevated and expectations are high that the Fed’s hand will be forced sometime soon.  The Fed is saving the bazooka of Operation Twist or yield curve control (YCC) for a massive move higher with Treasury yields.  In the meantime, the Fed could shift a portion of its asset purchases from mortgage-backed securities to Treasuries.

Gold prices need the Fed to deliver something on Wednesday, otherwise it could get ugly very fast.  Gold could attempt a run towards USD1750 leading up to Wednesday’s FOMC policy decision.

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