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WCU: Commodity markets consolidate with one eye on inflation

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector remains in consolidation mode with the Bloomberg Commodity index trading close to unchanged for a third week. The modest correction since February has served the market well in bringing down some of the speculative froth, thereby preparing the market for the next leg higher once supported by strengthening fundamentals. One concern for the market relates to China and the risk of tighter monetary conditions being introduced in order to curb rapidly rising factory gate prices.


The commodity sector remains in consolidation mode with the Bloomberg Commodity index trading close to unchanged for a third week. After peaking at a three-year high in late February, following a 50% surge on vaccine and growth optimism, it has since seen a modest correction as the dollar and Treasury yields strengthened while extended lockdowns have prevented a further recovery.

In energy, Brent crude oil continues to consolidate in a $60 to $65 range following the March rejection above $70/b. The prospect for stronger global economic growth, upgraded to 6% by the IMF this week, currently helping to offset the impact of a resurgent coronavirus just as OPEC+ prepares to add supply over the coming months.

Financial flows into commodities have as a result also slowed with hedge funds turning net sellers for the past five weeks. During this time, a record net long across 24 major commodity futures has been cut by 18% and, while impacting all sectors, the bulk of the reduction has hit the metal sector, especially HG copper.

Industrial metals, which led by copper surged higher by more than 40% during the past year, have also reached a consolidation phase on easing supply tightness as exchange-monitored copper inventories in London and Shanghai have risen, as well as concerns that rapidly rising factory output prices in China could see the world’s second-largest economy slam the brakes and tighten monetary policy conditions.

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China’s March PPI, or factory gate prices, beat analyst expectations to rise 4.4%, their fastest annual pace since July 2018. Most of the strong rise can be explained by surging commodity prices, and with this in mind we know there is more to come over the coming months. The chart below shows how crude oil will continue to add upside pressure, not only to Chinese PPI but global inflation in general, as the year-on-year impact of last year’s price surge will be felt at least until next January. These developments have raised concerns that China, despite gathering economic momentum, could see the country’s central bank tighten monetary policy and thereby dampening the flow of money into financial markets.

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Agriculture: The continued rise in food price inflation was confirmed once again this past week after the UN FAO published its March World Food Price Index. The index, which consists of 95 price quotations from five different commodity groups, rose for a tenth consecutive month to its highest level since June 2014, an annual rise of almost 25%. With the exception of meats, all sectors are showing strong annual price increases led by vegetable oils such as palm, soybean and rapeseed at 86%, followed by sugar (+30%) and cereals (+26.5%). The latter group comprising the critical global staples of wheat and rice, which fortunately at this stage have both seen relative small increases, thereby reducing the risk of food insecurity.

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    US corn and soybean futures meanwhile trade close to multi-year highs following the recent release of the Prospective Planting report which turned out to be a shocker after pinning the allocated acreage for both crops at lower-than-expected levels. Wheat meanwhile tries to recover from its recent 14% slump supported by dry weather across several spring wheat growing regions. Corn, however, is likely to attract most of the short-term attention as strong export demand continues to drive down domestic inventories, and prices up to an eight-year high.

    While soybeans and wheat both saw long liquidation from speculators in recent weeks, the corn long has reached a ten-year high at 396k lots. Overall, the net long across six soy and grains, currently at 684k contracts, saw the biggest one-week reduction since last May recently, and corn now accounts for a whopping 58% of the total net length.

    Metals: Investors’ confidence in precious metals received a knock during the first quarter with gold and silver being two of the worst performing commodities. Gold lost almost 10% while silver managed slightly better given its link to better-performing industrial metals. However, what became clear was the metals’ inability to find a defense against rising bond yields and a stronger dollar. Being the most interest rate and dollar sensitive of all commodities, the weakness was perhaps not that surprising as the dollar rose and bond yields spiked higher amid a stronger-than-expected recovery in global and especially U.S. growth.

    Having slumped almost 20% from the August peak, gold has during the past month twice managed to find support in a critically important area below $1680, and during the past week the yellow metal, supported by a dovish US Federal Reserve, managed to recover to a five-week high and almost challenge the equally important area of resistance around $1765. Although, in his comments Jerome Powell, the Fed chair, also played down the risk that inflation could get out of control, gold may suffer further losses if the market accepts his view and Treasury yields continue to rise on raised growth instead of higher inflation prospects.

    However, considering that most of the so-called hot or short-term money has already left the building, we currently view the risk of a major move being skewed to the upside. Through the data we see how under owned the market currently is. Open interest in COMEX gold futures is down 25% from their July 2020 peak, while the speculative long held by money managers has shrunk by 82% from its peak a year ago. Finally, total holdings in exchange-traded funds have seen almost continued reductions since January with the total down 10% from the record 3459 tons last October.

    Should gold manage to break higher, the biggest winner looks set to be silver which currently trades relatively cheap to gold with the XAUXAG ratio having risen to a 2-1/2-month high close to 70 (ounces of silver to one ounce of gold) from a recent low at 64.    

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    Source: Saxo Group

    Our recently published Quarterly Outlook titled “The world is short of everything” can be accessed here. In it we take a closer look at the short to medium term macro-economic outlook and how it may impact the different asset classes of forex, stocks, commodities and bonds.

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