Crude oil and low-risk, short-term cashlike investments emerged as the best-performing assets in the July-September quarter, while long-term bonds sold off heavily. Front-month WTI crude closed the quarter at $90.79/bbl, good for a 28.5% Y/Y gain and the best showing since Q1 2022, while front-month Brent crude ended the quarter at $95.31, up 27.2%.
Energy stocks also enjoyed a productive period, with the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) returning 17%. XOP invests in stocks of companies operating across oil and gas exploration and production sectors. Top holdings by the ETF are Denbury Inc. (NYSE:DEN), Ovintiv Inc. (NYSE:OVV), Valero Energy Corp. (NYSE:VLO), Exxon Mobil Corp. (NYSE:XOM) and Chord Energy Corp. (NASDAQ:CHRD). XOP is a pretty well diversified ETF with 61 total holdings, with each of the stocks in the Top 10 holdings having a weight of ~2.5%.
The S&P 500 energy sector was up about 14% in the third quarter, the only industry component of the benchmark index that recorded a positive return. In contrast, the broad-market benchmark the S&P 500 slipped by 3.6%. However, energy stocks have lagged the broad market with a 7.1% return vs. 12.0% in the year-to-date timeframe.
Oil Prices Defying A Strong Dollar
"Oil prices saw a strong rebound in Q3, which followed a run of 4 consecutive quarterly declines. Natural gas prices also moved higher, with those in Europe up +12.8% to €41.86/MWh, after a run of 3 consecutive quarterly declines. The dollar index strengthened by +3.2% in Q3, aided by a sharp rise in US real yields. Conversely, other major currencies weakened against the dollar, including the euro (-3.1%), the Japanese yen (-3.4%) and the British pound (-4.0%)," Deutsche Bank's Henry Allen has written in a note.
The U.S. dollar has strengthened considerably over the past three months after the U.S. economy proved more resilient than expected, thus fuelling appetite for American financial assets. The U.S. Dollar Index, a metric that pits the American currency against a basket of six global currencies including the Euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona, has gained 7.2% since mid-July in one of its strongest runs in recent times.
But the bulls can thank a sustained fundamental tightening in oil markets for helping counter a brawny dollar as well as concerns about a higher-for-longer rates cycle. Two weeks ago, the U.S. central bank left interest rates unchanged but bolstered its hawkish stance with a further rate increase projected by the end of the year. Higher interest rates tend to be bearish for oil prices because they usually translate to less demand for oil as activity declines with higher costs.
StanChart has predicted a further 1.3 million barrels per day (mb/d) fall in global crude inventories in Q4, following 2.1mb/d of draws in Q3. The analysts have noted that while slow to join the rally, speculative funds have now moved to the long side of the oil futures market. StanChart’s proprietary crude oil money-manager positioning index is now at a 44-month high of +16.7.
That said, oil prices might not have much upside at this juncture. Barring a supply crisis, few analysts expect oil prices to go past $100/bbl in the near term, with most predicting that prices will remain around current levels for the next couple of months. According to commodity analysts at J.P. Morgan, the push towards $100 oil is not sustainable because high oil prices will eventually dent demand. Indeed, JPM has reported that higher oil prices appear to be already affecting demand adversely, with gasoline consumption dropping in July month-on-month more than usual, while airlines recently reported that sales came in at the lower end of expectations.
"Demand risks are shifting to the downside. With pump prices surging and a seasonal travel peak now behind us, a greater share of demand in the fourth quarter will be concentrated in sectors more sensitive to economic growth," Natasha Kaneva, JPM's head of global commodities strategy, has written in a note.
By Alex Kimani for Oilprice.com
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