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"Huge Disconnect Between Physical & Futures" Suggests Commodity Rally Won't Last, Barclays Warns

Tyler Durden's picture




 

For many reasons the answer to the question: “will the commodity price rally continue?” is particularly important at this juncture, and the answer from Barclays is 'no' - it will prove very tough to make further significant gains in commodity prices from here unless supply/demand conditions improve very fast indeed. There are a multitude of factors but what erks them the most is the huge disconnect between price action in physical markets where differentials are signalling oversupply and futures markets where all looks rosy. The risks for a reversal in recent commodity price trends are growing, and with fewer market makers to absorb the shocks, potentially, a period of high volatility could lie ahead.

One of the most important financial market trends of Q2 so far has been the strong performance of energy and industrial commodities. However, prices appear to have moved ahead of the improvement in underlying fundamentals, and with fewer market makers to absorb the shocks, potentially a period of high volatility could lie ahead.

The first half of Q2 has seen a strong rally develop in commodities prices. Brent crude oil is up 24% (after performing flat in Q1), copper 12% and even gold has risen a little. Despite the fact that agricultural commodities and livestock prices have continued to be weak, the S&PGSCI spot price index has made its best start to a year since 2011, up 8% in the year-to-date.

Although the price rebound is directly benefitting commodity index investors much less then the spot price gains might suggest (because the high cost of carry has reduced total returns), the strength of the commodity recovery is greatly influencing global growth expectations and movements in other asset classes.

  • Just as the steep decline in oil prices in late 2014 kicked-off concerns about the health of the global economy, the recovery is being viewed by some market observers as a strong indicator that growth prospects may be improving faster than markets had expected, especially as it is heavily focused on energy and industrial metals.
  • The recovery in oil prices, in particular, is helping to allay concerns that important parts of the global economy might slip into a deflationary spiral. As investors have become more confident about the future (or at least less pessimistic), many of the deflation-axed positions built up earlier this year, especially in fixed income markets, are being unwound.

Consequently, the commodity price rally has been an important influence on the recent pickup in global bond yields. Although these remain low versus historical levels some of the recent action has been eye-catching (US 10y treasury yields and the 10y BUND are both up about 45bp since mid-April, to reach year-to-date highs) and it is hard to imagine that the moves would have been quite as aggressive without the big move up in commodities, particularly oil.

 

So for many reasons the answer to the question: “will the commodity price rally continue?” is particularly important at this juncture. Our view is that it will prove very tough to make further significant gains in commodity prices from here unless supply/demand conditions improve very fast indeed. In our view, prices for key commodities like oil, copper and gold, have already hit levels that would not be justified until later in H2, ie, following a longer sustained period of improving fundamentals than we have seen in H1 to date.

Indeed the risks are growing that the commodity price rally has moved too far ahead, too fast and that a steep downward adjustment could be just around the corner. In our view, there are several warning signs in commodities markets that we would advise investors across all asset classes to monitor closely.

China looks fragile. China’s commodity demand has had a reasonably strong start to the year with oil demand up 7.2% and copper up 4% in Q1. However, these figures are at odds with downbeat IP data (Figure 3) and imports have probably been boosted by stockpiling, especially for strategic commodities like oil and copper. April data released on Friday showed reasonably healthy import levels for these two commodities, but iron ore and soybeans were weak. The risk is that domestic demand and commodity imports could fall back as Q2 progresses.

 

 

Supply is still exceeding consumption. In particular, it still does not appear that the supply cuts necessary to balance the oil market are being made fast enough. Although there has been some slowing in the rate of US supply growth and a rapid decline in the rig count, offsetting that is the fact OPEC production has risen by 500kb/d since the start of the year to 31m b/d. If OPEC maintains that output level through Q2, then even with a further slowing in US oil production, the oil balances of the major forecasting agencies (and our own) indicate that global oil stocks will rise more quickly in Q2 than in Q1 (Figure 4) and to continue climbing through to year-end at least.

 

The oil price recovery may encourage some US producers to restart. EOG, often viewed as one of the best positioned independent US shale oil companies, said this week that if oil prices “stabilise at the $65 level” (less than 10% above current levels) it is prepared for “strong double digit” output growth in 2016. Moreover, the flattening of the WTI futures curve will add to the incentive for producers to gradually bring on drilled, but uncompleted wells. Neither the current trajectory of oil prices nor production looks sustainable to us in such a scenario. Something will have to give.

 

Finally there is a huge disconnect between price action in physical markets where differentials are signalling oversupply and futures markets where all looks rosy. Financial drivers have been key in this commodity rally, with short-covering driving part of it, but fresh longs being drawn in. Net speculative length in Brent crude has doubled since the start of the year to its highest level since data collection began in 2011. In copper the LME net long position has grown by 60% since the start of the year and on COMEX copper, speculators have swung rapidly from short to long.

The risks for a reversal in recent commodity price trends are growing, in our view, and with fewer market makers to absorb the shocks, potentially, a period of high volatility could lie ahead. Energy markets, especially oil, look most exposed and although copper fundamentals are firmer and prices less at risk of a large downward adjustment, volatility is likely there too, especially if further weakness in China becomes evident.

Source: Barclays

 

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Mon, 05/11/2015 - 12:15 | 6081201 This is it
This is it's picture

What rally?

Mon, 05/11/2015 - 12:21 | 6081229 jaxville
jaxville's picture

   Oil alone is up almost 50% over the last couple of months.

Mon, 05/11/2015 - 12:35 | 6081274 Pinto Currency
Pinto Currency's picture

 

 

The LBMA 'physical' market for gold and silver trades 200 M oz of gold and 1.5 B oz of silver per day.

These markets supposed to be physical but are paper as well.

It's all paper.

Mon, 05/11/2015 - 12:59 | 6081379 nope-1004
nope-1004's picture

Barclays:  First class liars in a satanic cult of thieves.  Ya, I'll trust just about anything these felons publish.

 

Mon, 05/11/2015 - 14:02 | 6081660 Fun Facts
Fun Facts's picture

The glue sniffers at Barclays must not have noticed that the Central Banks now manage prices with open market operations.

Mon, 05/11/2015 - 12:16 | 6081205 KansasCrude
KansasCrude's picture

LMAO,  when the dollar gets revalued down about 50% these prices will look cheap.  

Mon, 05/11/2015 - 12:27 | 6081249 BanksterSlayer
BanksterSlayer's picture

Thank you, Kansas! Any blog or reader's message here on ZeroHedge that does not take the looming Dollar re-val (read: "crash" or "death") into account is a waste byte space.

#ScheissDollar ahead.

Mon, 05/11/2015 - 14:16 | 6081739 sun tzu
sun tzu's picture

When the dollar is revalued down 50% people won't have money for anything other than food, obamacare, and shelter. That's the problem with commodities permabulls. They think because oil or NG is needed, prices can increae 1000% and there won't be any effect on demand. All you need to do is look at oil consumption in third world countries. It's almost non-existent compared to the developed world. Why? Because most people spend all their money on food and shelter. There's nothing left for luxuries like cars, planes, and other toys. Let's say oil goes to $500 and gasoline to $30 tomorrow. You're looking at immediate economic collapse and demand for all commodities will follow quickly. At $30 gas,95% of Americans will have empty bank accounts and maxed out credit cards within a month. They may need to fuel up to get to work or whereever, but what happens when they get to the pump and their credit and debit cards are rejected? No more demand for oil. Nearly every car, boat, and airplane will be idle until prices collapse back to affordability. Why do you think oil prices collapsed from $140 to $40 within a few months back in 2008?

Mon, 05/11/2015 - 12:18 | 6081211 JBilyj
JBilyj's picture

Gold and Silver are going to go down soon, I say this as a long term investor in pms.

Mon, 05/11/2015 - 12:29 | 6081253 jaxville
jaxville's picture

   A drop in commodity prices is always exploited by the financial authorities to attack precious metal prices. 

    Currently retail demand for silver is very lame whereas gold sales remain strong.  We are buying most of our silver across the counter rather than from our suppliers.  It is great for margins but it makes me sad to see long time savers exiting their positions. 

 

Mon, 05/11/2015 - 12:19 | 6081219 Kaiser Sousa
Kaiser Sousa's picture

http://www.kitco.com/charts/livesilver.html

and it still will not work....

Mon, 05/11/2015 - 12:20 | 6081223 jaxville
jaxville's picture

  I can see that commodities in general have run a little higher than fundamentals would support.  I wonder how gold will fare when commodities correct?  Many investors still view gold as a commodity rather than money.

 

Mon, 05/11/2015 - 12:36 | 6081284 TeamDepends
TeamDepends's picture

Then they can not be considered investors. Gold will go to the moon because it is what the bankers consider money, despite what they say.

Mon, 05/11/2015 - 13:00 | 6081333 Arius.
Arius.'s picture

@jaxville

 

what investors?  Joe six pack?  Do you really believe they matter?  might as well believe their vote matters.

 

there are only few investors who matter and they are the ones in charge of printing the money ... hence, they always buy as much as they can without scaring away the pray ... thats history books for centuries and millenniums ...

 

IF you are able to make the connection between printing money for free and buying real assets with that paper there is nothing else to know.

 

everything else is mirrors .... but there are plenty of false prophets ...

Mon, 05/11/2015 - 13:17 | 6081461 jaxville
jaxville's picture

   It is the smaller "investors" who actually take physical metal.  Most of the larger investors are merely speculating on precious metal prices through various paper proxies.

   We often hear of the 75% that have no savings and they only own that which they can finance.  The 25% or so that have savings can easily inhale all the retail gold that is currently available.  There are more than enough small investors who are one step away from the cognitive dissonance to make them precious metal savers.

   The big guys can move the price around but it is the little guys who can empty the shelves.

 

Mon, 05/11/2015 - 12:21 | 6081228 Omega_Man
Omega_Man's picture

Putting copper and gold in the same sentence makes central bankers happy

Mon, 05/11/2015 - 12:24 | 6081238 Winston Churchill
Winston Churchill's picture

'Cause we know the bankers stole all Ukraines' copper that night as well ?

Mon, 05/11/2015 - 12:24 | 6081237 Yen Cross
Yen Cross's picture

  I think these guys are probably mostly right. I'm not going to include gold and silver. I think we're going to see some strengthening in $usd again.

Mon, 05/11/2015 - 12:25 | 6081242 Winston Churchill
Winston Churchill's picture

Any thoughts on cable ?

Mon, 05/11/2015 - 12:42 | 6081309 Yen Cross
Yen Cross's picture

 The 200day avg. is around 1.5640. It looks like it's doing a small retrace as we speak. I might dip in for a short during Asia session in front of the industrial production numbers later.

Mon, 05/11/2015 - 12:27 | 6081247 madbraz
madbraz's picture

i feel much better now that a bank who is convicted of rigging markets is giving an "honest" opinion on such markets.

Mon, 05/11/2015 - 12:32 | 6081263 the grateful un...
the grateful unemployed's picture

and JPM is trying to corner the silver market. its obvious that commodity prices versus that of the underlying fiat currency says more about the currencies weakness. would you rather hold silver, oil or copper, or fiat?

Mon, 05/11/2015 - 12:49 | 6081349 GTC
GTC's picture

The only way metals prices go up is if I reopen my futures account and short gold and silver. 

Mon, 05/11/2015 - 12:51 | 6081362 teutonicate
teutonicate's picture

The people who control Reuters are the same people that control the CB's.  They want you to think that PM's are just like any other commodity, and therefore do NOT represent a more stable store of value than the artificially overvalued fiat currencies which they control.

There is a good chance, given the weakness in the global economy that industrial commodities may weaken.  By lumping PM's into this same category, and then claiming that commodities in general are overvalued, Reuters can weaken sentiment for PM's and reduce the cost of their cronies’ HFT short-side stop chasing (like they did this morning) to suppress PM's and prop up fiat.

Don't bite on it.

Mon, 05/11/2015 - 12:57 | 6081381 Arius.
Arius.'s picture

still looking under the light to find my keys lost accross the street on the dark ... the best ever ... :)

Mon, 05/11/2015 - 13:06 | 6081418 teutonicate
teutonicate's picture

Please excuse typo in last post, "Reuters" should read "Barclays".

Mon, 05/11/2015 - 12:52 | 6081366 Chuck DeBongo
Chuck DeBongo's picture

Well, silver and gold got slammed today.

I must admit I am losing some faith in my bet and wonder if I went the right direction. But I'll eat my losses with a ton of Tabasco sauce. I'm not a bankster.

But now things are calming down, I can't see where the "Black Swan" is going to come from. Even Greece is turning out to be a damp squib!

Gah!

Mon, 05/11/2015 - 13:27 | 6081510 Conax
Conax's picture

They both look like fish hooks to me, a V recovery in the works.

OT: WTF is going on with the DJIA tickers? CNN and WSJ both show a totally flat line with a few sharp down spikes then right back to sea level..

This ain't right.

Mon, 05/11/2015 - 13:20 | 6081473 tuttisaluti
tuttisaluti's picture

If silver drops further I will go all in. 

 

Mon, 05/11/2015 - 13:22 | 6081483 Fukushima Fricassee
Fukushima Fricassee's picture

Long Puntang, the commodity of champions !  Gold and silver hold value better than puntang !!

Mon, 05/11/2015 - 13:23 | 6081492 Lin S
Lin S's picture

< PM prices will move down before they move up.

< PMs to hold curent prices, then move higher.

Mon, 05/11/2015 - 14:41 | 6081851 Eastwood
Eastwood's picture

"Finally there is a huge disconnect between price action in physical markets where differentials are signalling oversupply and futures markets where all looks rosy."     they don't explain or quantify cash / physical market and subsequent basis risk. probably a piece targeted at their own version of muppets to get them short, at least temporarily, and protected with "tight" buy stops.

Mon, 05/11/2015 - 16:21 | 6082328 Quinvarius
Quinvarius's picture

Blah blah blah...  Hyperinflation never stopped being the problem, banktard.  Not for a second.

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