The global economy is sending bearish signals for energy and base metals, such as copper, as major emerging market economies such as China and Turkey are experiencing a downturn. We anticipate that this slowdown in the global economy would have the biggest impact on crude oil prices compared to any supply shocks coming from Iran or Venezuela. But rather than an outright short on commodities, we'd prefer a spread bet between long energy and short base metals.
On the equities side, we would prefer to go long the Energy Select Sector SPDR ETF (XLE) and short the Materials Select Sector SPDR ETF (XLB) . The XLE has more than doubled the returns of the XLB over the last 12 months, to 16.3%.
According to the International Energy Administration (IEA), developing markets are likely to generate around 1 million barrels a day of incremental demand in 2018, or about 75% of the global growth, which is a bullish sign. However, some of these countries are in the middle of their own economic challenges. Those challenges include recent currency crises in Turkey and Argentina and contagion effects in Indonesia, as well as China's reported slowdown, which together are putting downward pressure to the outlook.
Measuring the 'Trump Effect' on Global Growth
The International Monetary Fund (IMF) said in July that the rate of global expansion appears to have peaked in some major economies and that the balance of risks has shifted further to the downside, mainly on the back of recently announced and anticipated tariff increases by the U.S. and retaliatory measures by trading partners. Growth projections have been revised downward for Argentina, Brazil and India, putting downward pressure on commodities. The IMF projects global growth to reach 3.9% in 2018 and 2019, in line with prior forecasts, but the expansion is becoming less even and risks to the outlook are mounting.
Our best play is to short the United States Copper Index Fund (CPER) as a hedge for any long trades in crude oil made via the United States Oil Fund (USO) . A more diversified commodities hedge is Glencore plc; the stock is already down 22% for the year and already has broken its 20-, 50- and 150-day moving averages.
Venezuela, the Barrels That Won't Come Back
The U.S. Energy Information Administration (EIA) expects Venezuela's crude oil production to drop below 1 million barrels a day by the end of 2018 and fall to 700,000 barrels a day by the end of 2019 amid economic instability. In our opinion, exports are likely to go down to zero.
According to a Forbes article, Venezuela already has warned eight international customers that it wouldn't be able to meet its crude oil commitments as the country has less than 50% of its committed exports available and it might need to declare force majeure on its exports as production drops and its ports are unable to ship enough crude. Impacted U.S. refiners from this shortage would include various Gulf Coast refiners; among them are Valero Energy Corp. (VLO) , Chevron Corp. (CVX) and Phillips 66 (PSX) .
Saudis at the Gate
For Saudi Arabia, the slump in emerging markets adds further complications in an already-challenging market and their production position is a wait-and-see. OPEC has looked to adjust crude oil production, anticipating unknowns such as the impact of Iranian sanctions on crude and the collapse in Venezuelan production. In this environment, Saudi Arabia may choose to be cautious.
According to OPEC figures, Saudi Arabia reported that it produced around 10.03 million barrels a day in May, 10.48 million in June and 10.28 million in July. Those figures are up from April, when it was producing less than 10 million barrels a day.
If Iran sanctions kick in, there's very little spare production capacity in the market to spark a rally in crude prices. But if the Saudis increase output as a cautionary measure against trade fears and emerging market demand slumps, prices could collapse.