By Ole S. Hansen | May 17, 2020

With parts of the world beginning to emerge from Covid-19 lockdowns the financial markets have tried to strike an optimistic note, not least supported by a wall of money and rock-bottom interest rates. Just like when a hurricane or natural disasters strike havoc, the longer-term impacts are first seen in the aftermath. During the past few weeks we have started to see the horrendous damage done to the global economy from many weeks of inactivity. 
The coming months are likely to see a wave of bankruptcies, major negative corporate earnings revisions and with that, the risk that unemployment will remain stubbornly high. Self-imposed social distancing will keep the whole experience industry from travelling and exhibitions, to restaurants and cinemas under pressure for months to come. The need to keep a distance will also inadvertently help demand for gasoline to recover with commuters and travelers opting to use their car instead of public transport. 
 
Adding to the above risks we have to contemplate the risk of a second wave of the virus wave in the second-half of the year, together with a developing Trump versus China blame game. With these developments in mind we see the risk of renewed stock market weakness, a stronger dollar and Japanese yen on safe-haven demand. The crude oil market, having rallied strongly on production cuts and demand recovery, will find a plateau sooner rather than later and precious metals look set to rally further on safe-haven and diversification demand, while food commodities will generally stay subdued on the outlook for ample supply. 
Following more than a month of rangebound trading, gold finally managed to break the shackles that had kept it tied to $1700/oz. Renewed stock market weakness, a warning about the outlook from the U.S. Federal Reserve and a continued surge in the number of people joining the jobless queue are just some of the recent drivers. 
The Covid-19 pandemic remains a very difficult beast to beat and it carries the risk of re-emerging in places where it had been knocked back. While still not under control in many countries, the U.S. and others risk a prolonged impact with some states or regions attempting to reopen before having the virus under control. 
Gold's breakout above $1720/oz has added some extra spice to silver with the gold-silver ratio falling to 107 (ounces of silver to one ounce of gold), the lowest since mid-March. The next key levels for the market to target are $16.5/oz followed by $17.50/oz. Gold meanwhile may need to break the April high at $1747/oz before seeing renewed activity from hedge funds who, just like silver, had spent the past month reducing bullish bets.
 
Straying on the subject of so-called paper demand for precious metals, there has been a major divergence between tactical and momentum following trading firms like most hedge funds and longer term investors, both retail and institutional, using exchange-traded funds backed by silver and gold. The Commitments of Traders report covering the week to May 5 showed that hedge funds, spooked by the near 40% collapse from February to mid-March, had cut bullish bets on silver by 85% since February to an 11-month low. Apart from a small dip in March, ETF investors have been continued buyers of silver ETFs since January. Total holdings have reached a record 98 million ounces. The same development can also bee seen in gold with ETF holdings continuing to reach new record highs while hedge funds have cut their futures net-long to an 11-month low. 
 
Also supporting metals in general are reports from Chinese research houses that commodity traders are hoarding tangible assets. Metal companies got cheap Covid-19 loans from banks and they seem to have piled that money into commodities, betting on a price recovery that is more profitable than their production activities. Something that may also partly explain copper’s recent strength and drop in inventories monitored by the Shanghai Futures Exchange. 
HG Copper reached an eight-week high at $2.43/lb before running out of steam. While news and improved economic data from China, the world’s largest consumer, remains encouraging the outlook in our opinion remains one of caution. Rising supply from the reopening of virus-hit mining operations raising the question of whether the pickup in demand, especially from Chinese manufacturers, will be enough to avoid a build in surplus stocks this year. 
With this in mind we remain skeptical that HG Copper will be able to mount a sustained rally above key resistance at $2.50/lb, an area that provided support for three years before the March break and collapse to $2/lb.
Crude oil continues to push higher and in hindsight the short-lived collapse to a negative WTI price last month probably saved the market and set in motion the recovery currently seen. Major producers around the world, potentially faced with heightened risk of tank tops and the price collapse spreading, stepped up their efforts to cut production. A development which together with a pick-up in demand was highlighted  International Energy Agency highlighted in their latest ‘Oil Market Report’ as a key reasons for the recovery seen during the past month.  
However, the rally has also resulted in collapsing time spreads which could see oil return from abandoned storage plays over the coming months. Apart from the current front month price developments in Brent crude, the charts below also show the narrowing six months spread between the July-20 and January-21 futures contract. 
With this development in mind combined with estimates that demand may not fully recover for at least another year, we suspect that the current recovery may eventually run out of steam. Also considering the risk that U.S. shale oil producers, some desperate to survive, will be able to restart shut-in production as the price reaches economically viable levels above $30/b. 
We maintain a longer term bullish view on crude oil but prefer to express this view through investments in well capitalized oil majors instead of products, such as ETF’s that tracks the underlying futures price.