Midyear Commodities Outlook Central Banks and Geopolitical Risks Drive Direction

Two of the most recognizable barometers of investor’s confidence have proven less effective in 2014. Central Bank actions have dictated the pace global economics and their intervention has disrupted the supply and demand of commodities. While the stimulus pushed by central banks in order to boost growth has been mostly beneficial to the energy sector it has also limited demand from countries such as Japan who are pushing for a weak currency that also translates to expensive energy imports. The major economies have record low inflation and while in the United States the levels are acceptable in Europe it’s a different story. The deflationary fears might prompt the European Central Bank to act sooner rather than later with more stimulus that might not make its way to consumers. Low inflation further reduces the appeal of gold as a hedge against rising prices.

Gold seems decoupled from geopolitical turmoil and has enjoyed little lasting benefit from safe haven flows after such events as the Russia-Ukraine conflict, the Malaysian Air jetliner incident, Gaza turmoil and the ongoing fighting in Iraq. After closing 2013 close to $1,200 the yellow metal has struggled to make a serious threat to the 52-week high of $1,400 and has only been able to print above $1,350 for a limited time before been driven below the $1,300 and the $1,250 levels. Currently is is slipping down from the $1,300 mark as the markets await on the United States Federal Reserve FOMC for further direction.

Oil was unaffected for the most part by the Libya port situation as there was little real risk to country’s ability to ship it’s supply. Expectations of global growth have steadily increased the price of crude in the last 12 months. In contrast to gold, growing emerging economies and the recovering United States have upped the demand for oil. Inventories have so far kept up with demand allowing for a steady increase in price with fewer price spikes. The Russia-Ukraine conflict was seen as a bigger factor but Europe had been stockpiling gas inventories to avoid a gas crisis like in 2006 and 2009. The increase in inventories would only be enough to last until October of 2014. The upside is that this year only 50% of the supply comes through Ukraine, compared to 80% in 2009.

Yellow Metal Physical Demand Wanes

Earlier this year China passed India to become the world’s largest consumer of gold. This had more to do with India taking a stance designed to control inflation and speculation on its currency the Rupee. Duties to import the metal were raised reducing the demand as prices become prohibitive. The decision was able to reduce Indian gold imports by 77% in the first half of 2014. July demand is usually weak given that there are no major festivals.

There was a jump of 65% in July because the Reserve Bank of India allowed more companies to trade the metal abroad. Earlier this month a Junior Minister of Trade issued a statement where he says there are no plans to lower the tariffs designed to curb gold purchasing.

Chinese appetite for the yellow metal has also subsided after a record 2013. Higher prices and a metal financing scheme scandal have driven the metal’s demand lower in 2014. Hong Kong has posted 4 months with continuing declining purchases. Demand for physical gold has been lower due to higher prices after the metal has appreciated by 8% on safe haven investments. This had led to 19% lower demand for gold bars and coins in the first half of the year.

Hedge Funds Increase Gold Bet

Large speculators have been undeterred by falling gold prices. The latest figures from the US Commodity Futures Trading Commission showed an increase of 3.1% in net long positions. The sentiment from these type of market participants is that a US Economic recovery will lead to higher rates and inflation reigniting the appetite for the metal as a hedge.

Black Gold With High Supplies Awaiting Pick Up in Demand

Oil prices have risen in the first half of the year. A stronger second quarter in the United States has begun to offset the first quarter that had an abysmal drop after a harsh winter. Emerging markets have also kept their growth rate and demand for energy continues to increase. Oil prices will continue to rise even though some technology advances, like shale oil, can increase available supply. Those new technologies won’t be ready for a couple of years even though there is a lot of excitement surrounding their impact to energy prices.

Emerging market demand might encounter a setback as the Fed moves from a low rate policy to a tightening one. USD strength will increase the price of oil across the board and might impact EM growth forecasts especially for energy importing nations.

Natural gas and other energy commodities have been displacing gold as a natural safe haven particularly in situations where its energy exporting nations that are having disruptions. The two major trends identified by Goldman Sachs were growing gold shorts and natural gas longs. A mirror image of what the market was experiencing in 2013 given the expected central bank action and the supposed higher supplies caused by shale gas.

US Economy Key to Rising and Falling Commodities

The United States accounts for 21% of oil consumption. A stronger economy will consume more energy and increase demand of oil-based products. Overall current demand has been weak and with ample supply the price of oil has been stable. Policy decisions from the Fed could kick start the US economy affecting energy prices worldwide.

The price of gold is stuck between the Fed and the ECB. Tightening and higher rates balanced against Stimulus and lower rates for longer. The Bank of England has suggested it might go this year with its rate hike. The Bank of Japan meanwhile is waiting for its assessment of the economy to worsen before it acts again with a new round of stimulus. A hedge against inflation is not needed if there is no inflation. Lower demand for physical delivery is expected from the top consumers: China and India. Given how other assets have filled the role the yellow metal used to have or how investors have diversified their safe haven flow it would be no surprise if gold continues to give ground in the second half of 2014.

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency
trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza