We have seen risk assets react violently to Middle East tensions and natural disasters in recent times. With the continued unrest, and recovery efforts, we have revisited our outlook for oil and base metals; two commodities that continue to be in the lime-light.
Outlook for oil
Just over a month ago we discussed the main drivers behind the recent surge in oil prices, and our view on where the black gold may be headed. Back then, we believed that the crude price above US$100/barrel was probably temporary, and that once the "geopolitical risk premium" was removed, oil would potentially retreat to somewhere in the vicinity of US$85 – US$90/bbl.
Last month saw the crude price very well supported as tensions in the Middle East and North Africa (MENA) persist, although headlines are no longer front and centre. The price hit a high of US$113.72/bbl, however its average figure is probably somewhere between US$105 – US$108/bbl. Coverage of the Libyan situation has diminished, but Gaddafi is still in power despite a NATO-led no-fly zone.
The other major factors supporting the crude price have been the events in Saudi Arabia, which became embroiled in the democratic uprising seen in both Libya and Egypt. To counter the unrest, Saudi leader, King Abdullah, promised the biggest public spending increases in three decades to help prevent the kind of violence that halted oil output in other MENA nations. Given that the bulk of Saudi Arabia's wealth comes from oil (as OPEC's largest producer), the increase to benefits will cost the Arab nation more than US$100 billion over the next few years, or approximately $15.50 a barrel, the price it needs to balance its budget.
With Saudi Arabia said to be worried about how a "collapse" in oil prices would affect its new higher budget commitments, it is set to use its production power to support prices and ensure the market doesn't become oversupplied. Having said this, there is a very good argument that a new price floor has been created in crude oil prices.
What traders are watching
We still feel the risk is to the downside for the crude oil price. However, our previous belief of the US$85 –-US$90/bbl range is probably too bearish given the developments in Saudi Arabia. Our outlook has shifted to somewhere between US$95 – US$100/bbl, which is probably fair considering the state of the global economic recovery.
For those with medium to longer-term time horizons, this could represent some trading opportunities on the short side. Traders could look to take short positions in physical crude oil or look to play the decline through stocks heavily exposed to the black gold.
Base Metals’ momentum
Several weeks ago we argued that the short-term demand destruction anticipated after the Japanese earthquake and tsunami would give way to a more reasoned argument that infrastructure rebuilding would in fact underpin a longer, more sustainable demand for metals. That thinking essentially proved quite accurate, with metals quickly recouping lost ground after an initial spike downwards.
Goldman Sachs issued an underweight position across numerous base metals this week. Many market participants perceive this as Goldman's call to the end of the current commodity boom, which we feel is a questionable view. Goldman has been "long" various commodities from very low prices and no doubt has been looking to lock in some profits. The firm may also foresee an upcoming period of relative weakness which may allow them to buy back into the same commodities at lower levels. This should not be confused with Goldman Sachs turning bearish on the longer-term commodities outlook.
One only has to look and see that Goldman currently has some of the most bullish end-of-year equity index targets out there: 1500 for the S&P 500 and 5500 for the ASX 200, both of which are approximately 14% above current index levels. This shows that it is still very bullish on the outlook for equities. And no one would be more aware that if equity indices are to reach these levels, buoyant metals prices and a strong performance from the materials sector would be required to do a lot of the heavy lifting.
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Updated 19/04/11
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