Quarter End- What To Look Forward To In Q3
- All about trade at the start of Q3
- An OPEC meeting on July 1-2
- Iran looms large
- A 25-basis point rate cut in July
- Lots of volatility on the horizon- Watch gold!
The end of a quarter is typically a time where dominant market participants influence prices as their compensation depend on closing prices. However, the end of the second quarter of 2019 was a bit different than previous periods as the most significant issue facing markets in the second quarter occurred after the settlement prices were set in stone and the markets closed for the long weekend. The commodities asset class did not move all that much in Q2 as it posted a loss of a little over one percent after rising by 6.72% in the first three months of 2019. After the first six months of 2019, raw materials prices were 5.23% higher compared to their closing prices at the end of 2018. The number of commodities that posted gains were a little less than the number that moved lower over the past three months.
On a quarterly basis, three commodities posted bullish reversals including, corn, gold, and coffee futures. Cotton went the other way as it posted a bearish pattern on the quarterly chart in Q2. The dollar index moved to the downside as the Fed told markets that the path of least resistance for the Fed Funds rate is lower over the second half of this year.
While Monday marks the start of the third quarter, Thursday is the July 4 holiday in the US. The markets will not get into holiday mode at the beginning of next week given the many issues facing commodities and all of the other asset classes that are waiting for the news from Osaka, Japan this weekend.
All about trade at the start of Q3
Commodities are global assets. In free markets, raw materials would flow around the world from points where the lowest cost producers would sell to consumers willing to pay the highest prices for their output. However, tariffs and subsidies are government policies that interfere with the flow and distort prices as they tend to create swollen inventories in one part of the world and shortages in others. At the same time, protectionism interferes with global economic growth. The trade dispute between the US and China is an issue that has a wide-ranging impact on the global economy because it is between the two nations with the world’s leading GDPs.
Trade negotiations between the US and China broke down during Q2 in May when President Trump became frustrated with the pace of talks and Chinese backtracking on some of the most significant issues. On May 10, the US slapped new tariffs on China, and the Chinese retaliated on May 13, increasing volatility in markets across all asset classes. After a period where the rhetoric between Washington and Beijing reached a new low, the mud-slinging declined as Presidents Trump and Xi scheduled a meeting at the G20 meeting in Japan at the end of June. The meeting took place on Saturday, and while there will be a moratorium on any new protectionist moves and a restart of earnest negotiations, it is not likely that any trade pact is on the immediate horizon.
Last week, Secretary of the Treasury Steve Mnuchin told markets that the two sides are ninety-percent there when it comes to a trade deal which injected hope into markets. However, cockeyed optimism over an agreement is a simplistic view as anyone involved in tough negotiations knows that the final ten percent is the hardest and the make-or-break factor for any deal.
The best result we can hope for in the aftermath of the summit is no new tariffs or retaliation, and a restart of talks with some compromise from the leaders of the US and China on some of the stickiest issues. The worst case will be more frustration and a return of the type of tit-for-tat actions we witnessed in mid-May.
As we move into the second half of the year, the trade dispute is likely to continue to dominate fears and concerns of investors and traders and cause periodic price volatility in markets. Keep an eye on the copper market as the red metal is a barometer of the Chinese economy. China is the world’s leading consumer of copper and base metals, and the prices of the industrial commodities move higher or lower with the ups and downs of the trade negotiations which impacts economic conditions in the world’s most populous nation. Copper traded in a range from just under $2.60 to just under $3 per pound on the active month COMEX copper futures contract since April and moved to the lows when the trade negotiations turned sour.
The weekly chart of copper futures highlights that the red metal went into the trade summit at around 10 cents per pound above the low, but 30 cents below the high since April. A trade deal would likely launch the price of the base metal to $3 or higher, but a prolonged dispute could send it to a new low, which would weigh on other commodities prices as copper is one of the leaders in the asset class. Copper could be the essential commodity to watch in Q3 when it comes to trade.
An OPEC meeting on July 1-2
OPEC was supposed to meet on June 25-26 to decide on production policy for the second half of 2019. However, the cartel decided to take a look-back option by rescheduling the meeting for the first two days of July so they could incorporate the results of the trade summit at the G20 meeting into their demand calculations. With 1.4 billion people, China is the leading consumer of energy in the world, and the future of the Chinese economy is a significant variable when it comes to the demand for crude oil.
The oil market has changed dramatically over the past years. The rise in US production has made America the world’s leading producer of the energy commodity with the latest data from the EIA, telling us that US output is 12.1-12.4 million barrels per day. The US now produces more oil than either of the two other leaders; Saudi Arabia and Russia. At the same time, while Russia is not an official member of the oil cartel, Russian Oil Minister Alexander Novack and President Vladimir Putin have been the most influential participants when it comes to OPEC production quotas. The Russians increased their participation in the cartel’s decisions in 2016 when the price of the energy commodity fell below the $30 per barrel level. At the most recent meeting late last year, the members of OPEC could not come to a deal on a level for a production cut until the Russians got involved on the second day of the meeting. No decision on production will come without Russian approval and participation at the OPEC meeting early next week. The odds favor a continuation of the 1.2 million production cut because of the recent price action in both Brent and WTI crude oil.
The weekly chart of the nearby NYMEX crude oil futures contract highlights that the price dropped from a high at $66.60 in late April to a low at $50.60 per barrel in early July. The midpoint of the trading range is at $58.60, and August NYMEX futures settled at 58.47 per barrel on the final day of Q2, right in the middle of the range.
The chart of the new active month September Brent futures contract illustrates that the pricing benchmark for two-thirds of the world’s crude oil fell from $75.59 in late April to a low at $59.45 in early June. At $64.74 on the final day of June, the price of Brent futures was below the midpoint for the period at $67.52, which means that OPEC not likely to increase production. The Saudi oil minister told markets that the sweet spot for the price of crude oil is $60-$70 per barrel, and the cartel is not likely to disappoint markets at their biannual meeting, which would send the price of the energy commodity lower in Q3.
Bullish and bearish factors are pulling the price in opposite directions as we head into the second half of the year. The increase in US output and economic weakness in China are bearish factors, which took the price of oil to the recent lows. On the bullish side is Iran, which could spell volatility for the price of crude oil and many other markets over the coming days and weeks.
Iran looms large
The tensions between the US and Iran mounted in Q2 when President Trump refused to extend exemptions to eight countries that purchase crude oil from the Iranians. The theocracy in Teheran promised that if they cannot sell their petroleum to customers around the world, they would take action to prevent other exporters in the region from transporting oil. In Q2, multiple attacks on oil tankers, missiles flying over the border from Yemen into Saudi sovereign territory, and the downing of a US military drone were retaliatory acts by the Iranians to the tightening economic noose created by sanctions. The rhetoric continues to fly back and forth between Washington and Teheran, and all signs point to rising tensions in Q3.
Any hostilities that impact production, refining, or logistical routes in the Middle East could cause supply concerns to rise and would increase the potential for upside price spikes in the crude oil futures market. At the same time, an increase in incidents or war in the Middle East would have a significant effect on markets across all asset classes. While President Trump offered to talk with Iranian officials to find a solution to the standoff, the leadership in Teheran apparently has no interest in any meetings with the leader of the US. The President told the world that a nuclear Iran is unacceptable. While the US did not retaliate to the downing of its drone in June, any attacks that cause the loss of life would be a different story. With both sides on high alert, the potential for conflict in the Middle East remains at the highest level in years.
A 25-basis point rate cut in July
At its June meeting, the Federal Market Open Committee of the US Federal reserve told markets that interest rates are heading lower later this year. The market now expects the Fed to cut the short-term Fed Funds rate by 50 basis points, but that could depend on the market’s reaction to the trade negotiations between the US and China. Any progress on a trade deal could cause the Fed only to act once and trim the Fed Funds rate by 25 basis points, which would disappoint many market participants.
The market is now ready for a 25-basis point cut at the July meeting at the end of the month on July 30-31. The leadup and aftermath of the next Fed meeting and statement by the central bank could cause lots of price variance in all markets as US economic data and the global economic and political landscapes will determine the next move by the US Fed. The statement that the Fed would pursue a more accommodative stance when it comes to monetary policy lit a bullish fuse under the gold market in Q2 as the yellow metal rose to its highest level since 2013 when it traded to a high at $1433.30 per ounce in late June.
Lots of volatility on the horizon- Watch gold!
The price action in gold is a warning sign for markets across all asset classes. The gold market broke out of a $331.30 trading range that had been in place since 2014 in Q2.
The quarterly chart of COMEX gold futures shows the bullish reversal in Q2 as gold traded to a lower price than the Q1 lows and settled the quarter at the highest price since 2014. The reversal could be just the beginning of the next leg to the upside in the bull market for gold that began in the early part of this century.
Moreover, gold has not only moved to the upside in dollar-terms. Gold has been rallying in all currencies, including the euro and yen. At the end of Q2, the price of gold in yen was around 0.60% below its all-time high, and in Australian dollars, it rose to above the A$ 2000 level which was a new record peak.
Gold is flashing a warning sign for all markets and is telling us that the value trend in fiat currencies is lower. While the Fed said that one of the reasons for interest rate cuts is that inflation is below its 2% target rate, gold is saying not so fast and that the value of the dollar and all world currency instruments continue to decline.
Q3 and the second half of 2019 is likely to be a volatile time in markets. Fasten those seatbelts; we could be in for a wild ride. Approach all investment positions or trades with a plan and use discipline when it comes to stops and profit targets. And, always remember that risk positions are long or short at the last tick rather than the execution price. In volatile markets, the initial reason for a risk position can change quickly. At the same time, as Jeff Miller recently pointed out, consider the risk before reward as controlling market exposure is often the difference between success and failure in markets.
I wish everyone a happy, healthy, and safe Fourth of July holiday!