Oil & gold prices heading higher; Insurance vs recession cuts

Middle East tensions can bolster oil and gold prices. Time to take a pause in the DM govvie rally.
Joanne Goh, Eugene Leow21 Jun 2019
    Photo credit: AFP Photo

    ETF equities: Rising Middle East tensions to take oil and gold prices higher

    As the US-Iran tension escalates, opportunities have arisen for gold and oil trades, which are accessible through ETFs.

    Gold prices have recovered from their lows and we think this rise could be sustainable. Rising political tensions, lower bond yields and USD on the verge of reversing should make the rest of 2019 very interesting for the metal. Gold prices have formed a wedge or pennant pattern that has been in place for several years. The positive aspect of this pattern is its trend of higher lows. Fundamentally, gold has been resilient, gaining strength from escalating geopolitical risks and uncertainties. Whether the aforementioned catalysts are strong enough to take gold prices to a new higher trend line remains to be seen.

    Oil prices have been volatile in the past one year as the tussle between supply and demand keeps prices in a wide range. Even as oil prices are near year’s lows recently due to a re-escalation in the US-China trade war, there is scope for an upmove due to rising tensions in the Middle East. DBS regional oil & gas team believe that supply risks are being underestimated at this point, as these are affected by stricter Iran sanctions, decline in Venezuela output, outages in Libya while demand concerns took centre stage. We thus expect oil prices to gradually recover from current levels, with Iran tensions as an immediate catalyst.

    Rates: Distinguishing between insurance cuts & recession cuts           
    By many measures, the rally in developed market govvies looks stretched. 10Y UST yields are already more than 120bps down its peak last year and is hovering around 2%. Similarly, 10Y German yields pushed to a fresh low (below -0.3%), reinforcing the fact that zero is not the floor for rates. Much of this is due to dovish guidance from the Fed and the European Central Bank (ECB) and the outsized reactions in the interest rates space. When the Fed indicated flexibility in lowering rates on account of heightened uncertainties, short-end USD rates took the chance to push even lower, factoring in 100bps of cuts within a year. Similarly, EUR bonds rallied when Draghi opened the door to rate cuts and quantitative easing (QE), with market participants factoring in 13bps worth of cuts by the end of the year.

    It is prudent to take stock ahead of the G20 meeting. US and Eurozone yields could well head lower over the coming months but risks that a trade deal could be struck between China and the US, it might make more sense to lighten up DM duration risks. We should distinguish between Fed “insurance cuts” versus a US recession call that would necessitate much more aggressive easing. Unfortunately, news narrative will be the main driver of DM yields in the short term. Beyond that, the scale of ECB easing is critical to watch. Suffice to say, a 20bps cut in the deposit rate and a QE package (not factored into our forecasts) would likely anchor DM rates, similar to the period in 2011-2012. In which case, it is conceivable for 10Y US yields to hover below 2% for an extended period.

    Joanne Goh

    Regional Equity Strategist

    Eugene Leow

    Rates Strategist - G3 & Asia

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