Brent oil futures are down 8% from their highs in July, whereas copper, lead, zinc front-month futures are down 20% over the same time. Yesterday, Brent oil joined the commodity rout and fell 3.5%. So what was the catalyst? A few things, really. But usual press will highlight geopolitical headlines and whatever sounds right to justify the move.
Going back to asking ourselves why base metals and commodities have been weak since the start of June, the answer lies in the potential for trade wars to ignite a slowdown in global economic growth (GDP) and subsequent pre-emptive collapse in raw material demand. That's how commodities trade. They are a blend of real demand plus perception of demand going forward. The supply side is easy to outline, it is the demand that moves the needle on the pricing. That is where it gets interesting.
The wheels have been set in motion for oil for some time. But everyone was too fixated on Iran sanctions and potential loss of 1 million bpd, when they forgot that OPEC plus non OPEC had closer to 2 million bpd already that they could pump if need be. It is what they cut back in 2016.
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We have seen the June and July production numbers from Saudi Arabia and Russia, and they are ramping up already. They did so even before the actual meeting held in Vienna. So if you have the balance of increasing supply and demand softening, given what is happening in emerging markets and economies printing softer macro numbers, it is inevitable that distillate (a barometer of global demand and GDP) demand falls as well.
The reason why oil is taking its time to fall is because we are in a gasoline summer driving season. It ends officially by labour day in September. We are close to it now. Demand numbers have been flat-to-softer, and refineries have cranked out as much gasoline as they possibly can to meet demand. Hence demand for crude has been strong (crude is used to make gasoline). Now post-September, the baton gets passed to distillate demand as winter heating season starts.
If you notice the DOE inventory data in the last few weeks, distillate demand has been softening or staying above 4 million bpd. Not growing. As refineries produced gasoline, they were boosting distillate production as well, as we were at record-low inventories earlier this year. This situation has now been resolved as production hit a seasonal record 5.34 million bpd. Distillate stocks are rising faster than the seasonal norm! This is a worrying development at a time when demand is supposed to be getting softer.
Brent physical market spreads have been showing weakness for some time. It just takes time to filter into actual spot price. Brent's six-month calendar spread remains in contango, and the move in the spread since late April has been the largest softening since oil prices slumped in late 2014. #mindthegap.
Added to that are macro hedge funds selling all assets linked to global economic growth and softness (a result of margin calls and liquidation in one part of the portfolio causing a reaction in other parts of the portfolio to contain risk). To top it off, DOE data yesterday showed a surprise crude build of +6.8 million bbl. Crude stocks are rising faster than seasonal norm. Add up all these developments and one can see oil prices back to $60-70/bbl. Hmmm, a healthy price for Trump and his domestic agenda? But also a neutral-to-positive price to boost production for OPEC and Russia. Win-win for all.
If one were to really look at fundamentals, copper has a deficit of 200,000-500,000 tonnes this year. The supply side is not getting easier, with ore grades lower. Sure, the market is worried about demand collapse in China. No doubt. But then the demand for oil in the rest of Asia should suffer too. And fundamentals for oil are actually looking bleak, with looser inventory balances. Perhaps yesterday was the start of a larger unwind?
