Despite the easing of trade tensions between the U.S. and China, OPEC production cuts and geopolitical tension in the Middle East, oil, base metals and gold prices are being weighed down by fears of worsening economic conditions in major economies. Kim Parlee talks with Bart Melek, Head of global commodity strategy at TD Securities.
- Hello, great to have you with us. Thanks for joining us tonight. Despite the easing of trade tensions between the United States and China following the G20 Summit and the extension in production cuts and geopolitical tension in the Middle East, oil, base metals, and gold prices were weighed down by fears of worsening economic conditions in major economies. Here to give us a little more perspectives and drill down is Bart Melek. He's head of global commodity strategies at TD Securities.
Bart, let's start with oil. Lots of forces going on, pushing the price of oil around. You've got China US, you have OPEC, you have production. Tell me, when you look at it, what is pushing oil up? And what's trying to push oil down?
- Well, oil has been very much pushed up by the expectations that OPEC plus group of producers will continue to restrict supply. As you know, early in the year, they've reduced their output by 1.2 million barrels per day. In fact, they over-complied with their promises and they have agreed to extend those cuts into next year, for the next nine months or so. So that has been a very positive factor, as have been the sanctions against Iran and the removal of waivers for importation of crude from that country.
All that has basically meant that if demand remains stable, we will see a tighter market and higher prices.
- Now, what about US China trade and production and just global growth. I mean, how does that play into it right now?
- Well, that certainly has upset the trend that we've been seeing that was moving oil to the upside from the supply side, mainly because the concern is, now, that if this China US trade deal doesn't happen-- in fact, if the tensions get even worse, and Mr. Trump applies another 25% tariff to an additional $300 billion worth of imports into the US, that could force the recession globally and reduce demand. If that's the case, then it could very well be that the expected tightening of the market doesn't occur and we get surpluses, and, perhaps, a significant downturn in oil.
For that reason, we've seen a very funny development, where we've seen the inventories drop. We've seen OPEC recently commit to these cuts and a day after, even after the G20 meeting pointed to less tensions, prices dropped. And that was in reaction to poor Chinese and European manufacturing data.
KIM PARLEE: All right. So when you take a look at this and you're making your forecast for oil prices, I mean, which trumps which, pardon the-- pardon the verb. But, yeah, where do you see prices going up or down from here?
BART MELEK: We're looking at quite stable price, in fact. We're looking at about $58 for the rest of the year, around 60. We don't expect a big rout in demand, while we do see a bit of a slowdown in global economic growth. But we don't see it so deep as to disturb the forecasts that most people have or change them. We still see about 1.3 million barrels a day of new growth in demand next year. And that would mean that the market does stay fairly tight.
In fact, the reason we choose $60 is not so much because of demand or even promises by OPEC, but it's more the marginal price of oil seems to be $60, which will drive further reaction from OPEC and will likely drive new investment in shale.
KIM PARLEE: What happens, though, if-- and from a fundamental standpoint I understand that with the shale piece, and you talk about the more production coming online. But Middle East tensions, we hear the Strait of Hormuz coming up all the time in the news. Maybe you can explain just the significance of it and what that could do.
- Oh, certainly. And in fact, I have written on it recently. And that could very well be a very big upside surprise. The risk is that tensions between Iran and the United States get out of hand and morph into something that materializes in an armed conflict.
Now, the problem is that some 17 million barrels of crude flow through the Straits of Hormuz, which is the world's most important choke point. And it is only about 12 miles away from potential artillery pieces or other tools of war that Iran might have at its access. And they could easily target tankers, if they so choose. That certainly would crimp the flow of crude, if that's the case. Any stoppage through the Strait of Hormuz cannot be replaced. Certainly not in the short or medium run very quickly. That could mean even triple digit oil if those tensions morph into a shooting war, per se.
- And that's something that, again, when you look at this, that's going to happen very quickly. And-- I'm assuming. It's not something that's going to kind of creep into the price. It'll happen-- it's almost binary.
- I think so. I think once these tensions get out of hand, it could go-- happen very, very, very, very quickly. We've seen that with the drone being shot over the Straits of Hormuz area, where prices started accelerating very quickly on the fear that there might be a US retaliation, and, therefore, a retaliation from Iran. And then things could go down-- you know, go south very, very quickly.
But there is even a danger that could escalate the prices slowly. And that would be threats from Iran that they will confiscate or maybe harm tankers, which could very well precipitate the lack of insurance for these flows. Insurers are very uneasy about sending tankers that are worth an awful lot of money into areas where they're at risk. And I'm not so sure that they would be covered. You know, there might be a force majeure because of a war act. So that could stop flows or reduce flows even if there's not a shooting war. But that, I think, would probably be more gradual.
KIM PARLEE: Interesting. I want to, if I could, just switch to gold. Same thing. You've always got forces pushing prices up and pushing prices down. We heard the Fed chair this morning talking about the fact that-- saying more-- that has the markets believe that rate cuts are more likely. What's all that mean for gold?
BART MELEK: Good things. We've recently taken a long position, or recommended a long position for gold. We've been in it some $100 ago. We're looking at 1,485 as an intermediate target. We think it could go even higher.
From our perspective, one of the biggest factors that drives gold is real interest rates. And if the Fed gets aggressive, which also implies other central banks get aggressive on the easing side, real interest rates could go down into negative territory quite quickly. We're already seeing negative yields for about $13.3 trillion worth of issuance globally. If that happens in the US, as well, the opportunity cost would be very low of holding a zero yielding asset. Well, zero is better than negative, isn't it?
Also, we think that if that's the case, then the global economy, broadly, would slow down and there would be risk to equity markets, as well. And volatilities and those risks would likely precipitate flows into gold.
KIM PARLEE: I've only got about 30 seconds, but you're talking about, obviously, if people are feeling the global growth outlook's not looking great, what that means for gold, but, also, then, what's the relationship between gold and copper? I mean, copper always tends to be-- it's the cliche PhD in terms of economics. So what's it telling us right now?
BART MELEK: Well, basically, copper is telling us that there will be a slowdown. It's telling us that the slowdown isn't going to be particularly sharp, but a slowdown nonetheless. Copper has been trading below $6,000 of the LME. And that's in spite of the fact that consensus is looking at deficits over the next two years or so. So copper is worried that things could go a little south, here, in terms of growth. And that, of course, would mean that the projected deficits could very quickly turn into surpluses and oversupply. So there is, I still think, a considerable downside risk for copper from here.
- Bart, thanks very much.
- My pleasure.