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Weakness into the weekend

By David Morrison  |  23/11/2018 14:19

Global stock indices, precious metals and crude oil were all sharply lower ahead of the first post-Thanksgiving trading session

Friday saw the release of a raft of Flash Manufacturing and Services PMIs from across the Euro zone for November. Yet again, the numbers from France, Germany and the overall Euro zone indicated a decline in positive sentiment when compared to the previous month. The decline in manufacturing this year being particularly pronounced and is perilously close to registering contraction. The news comes just weeks before the European Central Bank (ECB) has said it will end its programme of monthly bond purchases. The euro pulled back sharply in a move that saw the EURUSD slumping back below 1.1400. The next line of support comes in around 1.1300, but a failure to hold here could see the pair revisit the 17-month low around 1.1200 hit less than a fortnight ago.

Italian stance softening?

Earlier in the week the European Commission recommended opening a disciplinary procedure against Italy. The decision appears to have galvanised Italy’s coalition government and there has been speculation that it could reign in some of its budgetary demands. The news helped to boost Italian banking shares while the spread for Italian over German 10-year government debt pulled back sharply from 325 basis points to just above 300. But it may be wise not to get too carried away. Italy’s two Deputy Prime Ministers, Luigi Di Maio and Matteo Salvini have made their current spending plans the cornerstone of the country’s escape from EU-imposed austerity and insist that the proposed increase in the budget deficit is the only way to boost Italian economic growth. It would be surprising if they backed down now.

US/China trade deal

Last night China’s Shanghai Composite closed 2.5% lower. The sell-off was a response to a report in the Wall Street Journal that the US is discouraging international companies from buying telecommunications equipment from Huawei amid concerns of espionage. This comes ahead of next week’s G20 meeting where it is widely hoped that US President Donald Trump will meet his Chinese counterpart Xi Jinping. If so, then it could be that the two countries come together and end their disagreements over trade. President Trump has said that China wants a deal "very badly". However, there are some serious sticking points over cybersecurity and US allegations over Chinese intellectual property theft that could prove too difficult to solve in just one meeting.

What next for crude?

Crude fell sharply again this morning. Ahead of the US open WTI was down over 5% for the session. The front-month contract broke below $51 to hit its lowest level since October last year. Yet just a few months ago analysts were telling us to prepare for WTI to top $100 going into 2019 citing Iranian sanctions, supply disruptions from Venezuela, Libya and Iraq, the OPEC+ production cuts and growing global demand. At the beginning of October WTI hit its highest level in nearly four years, closing in on $80 per barrel. But then prices turned sharply lower. One reason was President Trump providing waivers to several key crude consuming countries over US sanctions on Iran. Also, in early October Saudi Arabia and Russia agreed to a private deal to boost output in advance of sanctions which subsequently weren’t applied in full. On top of this, reports show that over the last few months the world’s three largest producers, the US, Russia and Saudi Arabia, have all hit fresh records in terms of crude production. It looks as if this was the trigger for a turn-around in prices.

Slowing demand growth

But the current correction is now in its seventh week. Today’s sell-off means that WTI has lost a third of its value since the beginning of October. So, this isn’t just a supply story but one of demand as well. There were warnings from the IMF last month that it now expects a global economic slowdown, triggered by soaring debt levels and rising trade protectionism. This can already be seen in China’s GDP numbers where the rate of economic growth is slowing.

OPEC meeting

The next big event is the OPEC meeting in December. The question now is whether the cartel (together with other non-OPEC producers) reintroduces its output cuts, and if so, by how much? But there will be some annoyance amongst producers that Russia and Saudi came to a bilateral agreement to raise output when the cut agreement was still in place.

Very oversold

The Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) suggest that crude is very oversold territory. In fact, the MACD shows that WTI hasn’t been this oversold since early 2015. This is typical for crude oil which is a real traders’ market which often goes from grossly oversold to grossly overbought in the blink of an eye. This is the time when traders look to capitalise on a major move in the expectation of a sharp reversal. But when to jump in? Markets can remain oversold (or overbought) for a very long time. It’s also worth noting that in January 2015, with the MACD overextended in negative territory, crude did bounce. However, it subsequently went on to make a fresh low, losing an additional 25%, one year later. For now, there’s some mild support around $50 but a retest of last year’s lows near $40 can’t be ruled out.


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