Commodities

  • With the Brent oil price hitting US$80/bl it is through gritted teeth that I need to admit that I was wrong and Goldman Sachs was right. I have checked back through the records of my 37 year financial markets career and this forecasting anomaly seems to be a ’black swan’ event with the likelihood of not happening again until 2055.

  • My view had been that oil would likely trade in a range of US$40/bl to US$60/bl that was governed at the lower end by the breakeven cost of US shale and OPEC’s desire for higher prices and at the upper end by a rapid increase in shale productivity and capacity. What appears to have changed is s a new convergence of interests between Saudi Arabia and Russia on the subject of the oil price (i.e. very much higher!) while shale capacity increases.

  • As we discussed in detail in the ‘Return of the Strongmen’ end- piece a couple of quarters ago, Saudi Arabia needs a high oil price because it has a large young population but few worthwhile employment opportunities due to a lack of investment in human capital and a lack of diversification in the economy. Mohammed bin Salman the heir apparent to the Kingdom of Saudi Arabia, is embarking on a ‘Vision 2030’ programme to build a modern, diverse and more dynamic economy but this is very expensive and needs to be financed out of oil revenues, ergo US$80/bl would suit just fine. Even though the US and other developed economies may be unhappy with a higher oil price given its inflationary effects they realise the strategic importance of a strong Saudi Arabia as their principal ally in the volatile Middle East and so are unlikely to kick up too much of a fuss. The other OPEC players do not appear to have the spare capacity or desire to confront a highly assertive Saudi regime and, for now at least, Saudi restraint is proving more powerful than shale abundance in setting the price of black gold.

  • Commodity prices have been volatile during the quarter as the Trump tariff threats and sanctions against Russia caused large swings in the prices of base metals and agricultural commodities as traders struggled to work out where and when they could be shortages or gluts of aluminium, nickel, or indeed soyabeans.

  • Gold has started to weaken in the face of higher interest rates and a strong US dollar. There are always plenty of reasons thrown into the pot as to what moves the gold price but historically the single most important driver of a rising gold price has been inflation, but only so long as interest rates don’t keep up. The key driver is thus the ‘real rate of interest’ i.e. interest rate adjusted for inflation. Gold does not pay any interest so one way to think of it is like investing in a zero coupon index-linked bond with no maturity date. Thus, if the best alternative ‘risk free asset’ (i.e.US Government Bond) is paying you a yield higher than inflation then it is a better investment than the yellow metal and vice-versa. Currently US 10 year Bonds pay a yield of 2.9% and US CPI is at 2.5%, hence the lacklustre performance of gold. The recovery in the dollar this quarter hasn’t helped the gold price either. Gold is priced in dollars so a stronger greenback makes it more expensive for holders in other currencies.

Summary: Oil prices remain firm having touched US$80/bl at one point which prompted a significant rally in energy stocks. Gold has weakened in the face of higher interest rates and a strong US dollar. Mining shares need continuing.

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