Welcome back to our latest edition of Market Insights with Sanjeev Kaushik.
In this edition, we dive into several pivotal topics influencing the financial markets. First, we revisit the gold market, where a resurgence in interest may signal a new golden era for investors.
Next, we analyze the potential impact of U.S. corporate tax reforms on S&P 500 earnings and how these changes could reshape the investment landscape.
Finally, we critically assess the Zebra Options Strategy, highlighting why this often-overlooked approach may not be the best choice for your trading needs.
So let’s dive right into it..
Today at a glance:
- Commodities Outlook: Gold Rush is Back
- Tax Cuts – Will the Next President Take Action?
- To Trade or Not to Trade Options?
- Options Strategy that Shouldn’t Exist!
1. Commodities Outlook: Gold Rush is Back!
As we move through 2024, the commodities landscape presents an intriguing mix of opportunities and challenges. While certain sectors of the market are facing downside risks due to weakening demand, particularly from China, others offer significant upside potential.
Notably, gold is emerging as a standout commodity in this uncertain environment. Keep reading as we break down the current outlook for key commodities such as oil, copper, and gold, exploring the major driving factors and potential strategies for investors.
1.1 Shift in Commodities Strategy
At the start of 2024, Goldman Sachs introduced a “Deficits Basket” expecting that strong global economic growth, U.S. interest rate cuts, and tight oil supply would boost key commodity prices. This approach started off well, with the U.S. economy growing, rate cuts on the horizon, and a positive outlook for oil. By mid-2024, this basket saw an 8% gain.
However, things didn’t go entirely as expected. Demand from China, especially for oil and copper, has been weaker than anticipated. China’s economic outlook has worsened due to factors like the rise of electric vehicles reducing road fuel demand and lower petrochemical consumption. Copper demand also dropped, leading to increased inventories.
In July, China’s economic data came in below expectations, with just 3.6% growth compared to the government’s 5% target. This slow recovery in China, which once drove two-thirds of global commodity demand growth, has become a major challenge for the commodities market. As a result, the initial optimism for the Deficits Basket has faded.
1.2 A More Cautious Stance on Oil
Oil has been a significant driver of the commodities market, but analysts have adopted a more cautious outlook. The forecast for Brent crude oil has been lowered by $5 to a range of $70-85 per barrel, with the 2025 average price now predicted at $77 per barrel.
Several factors contribute to this more conservative view. Oil inventories in OECD countries have remained flat, contrary to expectations of a seasonal decline, driven by higher-than-expected U.S. natural gas liquids (NGL) production.
Additionally, China’s oil demand has weakened as the country transitions to cleaner fuel alternatives like electric vehicles and natural gas trucks. As a result, the global oil demand growth forecast for 2024 has been revised downward from 1.2 million barrels per day (mb/d) to 0.9 mb/d.
The Road Fuel Shift From Oil to Power and LNG Explains the Bulk of Slowdown in China Demand Growth in 2024H1 vs. 2016-2019.
This decrease in demand suggests a smaller oil supply deficit in 2024 and a potential surplus in 2025. Further risks, such as high global supply capacity, potential trade tensions, and OPEC’s ability to increase production, add to the downward pressure on oil prices.
Given these uncertainties, oil producers are being advised to hedge their exposure by purchasing put options, which remain relatively inexpensive. This strategy would help protect against potential price declines while still allowing producers to benefit from any unexpected price increases.
1.3 The Delayed Copper Rally
In 2024, copper, a key industrial metal, has struggled due to a mix of strong supply and weak demand. Despite disruptions in major copper-producing countries, refined copper production remained high. Meanwhile, China’s copper consumption declined, leading to a buildup in inventories, contrary to the usual seasonal trend. This was further impacted by the ongoing weakness in China’s property sector.
As a result, the target price of $12,000 per ton for copper has been delayed to post-2025, with a revised 2025 forecast now set at $10,100 per ton, down from the previous $15,000 target.
Despite these short-term challenges, the long-term outlook remains bullish, driven by increasing demand for green metals and decarbonization efforts.
1.4 Go for Gold!
In contrast to the cautious outlook for oil and industrial metals, gold shows strong potential for near-term gains. A bullish price target of $2,700 per ounce has been set for early 2025, supported by the following key factors:
Central Bank Purchases: Since mid-2022, central banks have tripled their gold purchases due to concerns about U.S. financial sanctions and sovereign debt. This trend is expected to continue, regardless of whether purchases are publicly reported.
Fed Rate Cuts: Anticipated interest rate cuts by the Federal Reserve are likely to draw Western capital back to gold, making it a more attractive investment as rates fall.
Geopolitical Hedging: Gold serves as a hedge against geopolitical risks like tariffs, financial sanctions, and concerns over U.S. debt. Analysis suggests that gold could see a 15% increase in response to rising financial sanctions, similar to trends since 2021.
While the original target of $2,700 has been shifted to early 2025 from year-end 2024 due to price sensitivity in China, this sensitivity also acts as a stabilizer. Any significant drop in prices would likely spur renewed buying from China, providing a price floor.
1.5 A Bearish Cycle for Global Gas
The global natural gas market is expected to enter a bearish phase over the coming years. While Europe remains vulnerable to price spikes during winter, particularly following the 2022 energy crisis, the long-term outlook for gas prices is more optimistic due to a significant increase in global liquefied natural gas (LNG) supply.
Starting in 2025 and continuing throughout the decade, over 200 million tonnes per annum (mtpa) of new LNG supply is set to enter the market. This far surpasses Asia’s annual demand growth of 20 mtpa, suggesting that lower prices will be needed to incentivize additional demand.
An Upcoming Wave of LNG Supply Capacity is About to Hit the Market Starting in 2025.
As Europe continues to absorb excess LNG, European gas prices are expected to fall, potentially dropping below 20 EUR/MWh to stimulate demand. If prices remain depressed, U.S. LNG exports could face temporary cuts, similar to the market disruptions seen in 2020.
2. Are Tax Cuts Coming?
As the U.S. presidential election looms, investors are closely watching potential changes to corporate tax policy that could significantly impact S&P 500 earnings. Both major candidates have proposed shifts to the corporate tax code, though it remains uncertain whether such changes will be enacted. The outcome of the election and whether the new president will have control over Congress will play a crucial role in determining the likelihood of reform.
Despite the uncertainty, analysts suggest that any corporate tax reform would materially affect S&P 500 earnings per share (EPS). The current U.S. statutory corporate tax rate on domestic income stands at 26%, but most S&P 500 companies pay an effective tax rate closer to 19%.
This discrepancy is largely the result of the 2017 Tax Cuts and Jobs Act (TCJA), which lowered the federal statutory corporate tax rate from 35% to 21% and altered the treatment of non-U.S. income. While the statutory rate is in line with the OECD median of 24%, it is still higher than the effective rates many U.S. companies currently pay.
2.1 Next Presidential Move: Tax Cuts in Focus?
Goldman Sachs analysts estimate that each 1 percentage point change in the statutory domestic tax rate could shift S&P 500 EPS by nearly 1%, or approximately $2 in projected 2025 earnings.
Each 1 percentage point change in statutory domestic tax rate would shift EPS by less than 1%.
If a new tax policy cuts the corporate rate from 21% to 15%, S&P 500 earnings would see a roughly 4% increase. Conversely, a tax hike scenario where the rate rises to 28% could reduce EPS by about 5%. Factoring in additional changes to foreign income taxation and an increase in the alternative minimum tax rate, the overall impact could slash EPS by up to 8%.
This sensitivity only reflects the direct influence of tax policy changes on earnings and does not account for secondary effects on the broader economy. Any adjustments in corporate pricing, spending behavior, or government fiscal policies could further complicate the outlook.
2.2 Lessons from the 2017 Tax Cuts
Looking back at the passage of the TCJA in December 2017, S&P 500 companies benefited from a significant earnings boost. The law increased aggregate S&P 500 EPS by 12% in 2018, as corporate tax liabilities decreased. During that period, the S&P 500 index rallied by roughly 10% in anticipation of the improved earnings environment, illustrating how tax policy can have an immediate impact on equity markets.
However, most investors tend to wait for legislative clarity before making significant portfolio adjustments. Following the 2016 election, high-tax stocks briefly outperformed their low-tax counterparts but traded sideways until the TCJA’s details were finalized. Once the law was passed, high-tax stocks outperformed more significantly, underscoring the importance of certainty in policy changes.
