The Oil Rally Continues

Oil: dipping below USD 60 as fears become fact

Darwei Kung (DWS) | The oil rally continues. On the supply side, OPEC and Rus-sia reached an agreement to extend the June production cap into July instead of implementing the planned scaling down of cuts. This is perhaps a sign that the major produc-ers are conscious of the oil market’s fragility despite the recent rise in oil prices. Large inventory overhangs support that fear. On the demand side, the re-opening of economies across the globe has brought significant optimism, even though the amount of realized demand that has emerged give little support for it.

The oil-price surge is consistent with overall strong market sentiment on the economic recovery. Recent data showing a small fall in U.S. unemployment has further boosted the recovery sentiment. However, we are cautious about the oil price after this rapid recovery. We expect supply to increase from OPEC and Russia in August. Some U.S. producers have also announced that production has resumed, thanks to the recovery in the oil price. We also expect the recovery in demand in countries outside China to be more gradual than current prices imply. Without an improvement in supply-and-demand balances the oil-price rally looks unsustaina-ble. Strategically, OPEC+ and other oil producing nations’ actions to remove excess production should help to allevi-ate the global inventory glut. This, however, is a gradual process, therefore we expect June 2021 future prices for West Texas Intermediate (WTI) to be 43 dollars per barrel.

In contrast to oil, we believe the rally in metals is supported by solid fundamentals. Strong fiscal stimulus in China has and continues to support the infrastructure sector, and Chi-na’s effort to increase the local government loan limit has certainly bolstered metal prices. Similarly, the United States and governments across Europe are talking extensively about increasing fiscal spending.

While copper demand has been hit hard by the pandemic, it has benefitted from these recent developments and there-fore inventories have not risen substantially. China’s infra-structure and construction plans in particular appear to sup-port a copper price of 6,060 dollars per ton by end-June 2021, a close to 4% increase on the current level. We share a similarly positive outlook for iron ore. Supply disruptions, with production slow to resume after Covid-19-related sus-pensions, shipping issues and strong rainfall in Brazil, cou-pled with solid demand, support this view. For other base metals, we are still cautious. We believe actual construction projects will likely roll out gradually and so demand growth in base metals may be slower than the current restocking activity seems to imply.

Gold, on the other hand, has given back a little of its recent gains, reflecting risk-on sentiment in markets. But we blieve it remains well supported, at over 1,700 dollars per ounce, holding up well in its two-month range. A weaker U.S. dol-lar, low real interest rates and higher inflation expectations are likely to support gold prices. Particularly important for gold is the widespread belief that the Eurozone and Japan are likely to retain negative interest rates for a long time to come. Additionally, the U.S. Federal Reserve (Fed) has agreed to extend the low rate regime into 2022. And the list of geopolitical risks is increasing, further supporting our constructive outlook for gold, with a forecast of 1,830 dollars per ounce by end-June 2021.

As for oil, so for sugar: we are not as optimistic about sugar or corn prices. Both commodities are set for high levels of production this year and increased demand for ethanol does create further demand for sugar and corn, but we view cur-rent prices as too bullish.

We reaffirm our belief that China will meet the requirements of its phase-one trade agreement with the United States. China has been consistently purchasing U.S. grains as the prices are very attractive relative to Brazil. We consider this to be supportive for prices of grains and livestock in the second half of the year. We expect U.S. grains in the com-ing planting seasons to be well bid.

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The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.