Head of Commodity Strategy
Summary: The Bloomberg Commodity index traded higher for a fourth week, supported by fears that the war between Israel and Hamas could spread across the Middle East, thereby raising supply concerns for crude oil and natural gas to Europe. In addition, worsening crop conditions across the Southern Hemisphere have given the agriculture sector a boost while an ongoing surge in US bond yields has led investors instead to seek safety in the Swiss Franc and not least gold. The yellow metal has rallied by around 160 dollars during the past two week, it highlights a market where traders and investors are growing increasingly concerned, not only about the geopolitical landscape, but also about US fiscal policy, and whether the recent jump in both real and nominal yields will break ‘something.’
The Bloomberg Commodity index traded higher for a fourth week, supported by fears that the war between Israel and Hamas could spread across the Middle East, thereby raising supply concerns for crude oil and natural gas to Europe. In addition, worsening crop conditions across the Southern Hemisphere have given the agriculture sector a boost while an ongoing surge in US bond yields has led investors instead to seek safety in the Swiss Franc and gold.
While the response in the energy market to the Israel-Hamas war so far has been muted given the difficulty in pricing the risk of an actual supply disruption, the gold market has been on a tear, surging by around 160 dollars during the past two weeks. This highlights a market where traders and investors are growing increasingly concerned, not only about the geopolitical landscape, but also about US fiscal policy, and whether the recent jump in both real and nominal yields will break ‘something.’
US Treasury yields have surged higher this month culminating on Friday when the 10-year yield touched 5%, the highest level since 2006, while at the short end the 2-year yield reached 5.25%, the highest since 2000. The surge in yields is pushing up mortgage rates, hurting borrowers while causing painful losses for many investment funds and banks that could, in turn, curb lending into the economy. It is also pushing up borrowing costs across the developed world and sucking money out of emerging markets, while raising the bar for when an investment in stocks makes sense.
In his latest speech, Fed Chair Powell sent a message that the FOMC is proceeding carefully. His comments mirrored those made by several other Fed members that the FOMC is likely to be on hold as the recent surge in Treasury yields has reduced the need for additional rate hikes. Over the past 20 months, the Fed has raised interest rates at the fastest pace in four decades, and the most recent hike in July pushed the benchmark federal-funds rate to a range between 5.25% and 5.5%, a 22-year high. Given these latest statements and recent bond market developments, we conclude that the FOMC is done hiking rates, and the focus will increasingly turn to the timing of the first rate cut and the number of subsequent cuts. During the past few weeks, traders have reduced rate cut expectations with the low point in rates being around 4.3% from less than 4%, a sign the market is looking for long-term inflation well above the central bank’s target near 2%.
Overall, the Bloomberg Commodity Total Return Index (BCOMTR), which tracks a basket of 24 major commodity futures, trades up 1.7% on the month with gains being led by precious metals, softs and grains while industrial metals continued to suffer amid concerns about the medium-term outlook for demand growth in China and the rest of the world. Overall, the Bloomberg Industrial Metal Total Return Index has suffered a near 15% decline this year, and with its 16% weighting in the overall Bloomberg Commodity Index, it remains the sector, together with grains (14% weighting and down 9%), that is currently weighing the most on the overall performance of the commodity sector, and the reason why the BCOMTR is currently down by 2% on the year.
Gold’s impressive 160-dollar rally during the past two weeks has seen it slice through several resistance levels, and in the process reached a 13-week high withing striking distance of the psychologically important $2000 level. The rally – which began on October 6 after another strong US job report failed to send prices through key support around $1810 – was turbocharged the following week after the Israel-Hamas war triggered an extremely aggressive round of short covering by wrong-footed speculators.
This past week, however, the rally picked up additional pace with gold recording one of its biggest daily gains since March’s banking crisis. However, with safe haven and short covering no longer the main drivers, something else aside from strong bullish momentum has emerged to support prices. We believe that the continued surge in US bond yields has traders and investors growing increasingly concerned about US fiscal policy, and especially whether the recent jump in both real and nominal yields will break ‘something’. This focus is also the reason silver and platinum have struggled to keep up with gold, potentially raising the prospect of a catching-up rally in both, should gold manage to hold onto recent gains.
The two charts below show the conundrum the market has been dealing with this month with gold surging higher while yields hit fresh highs. It is also worth noting that total holdings in bullion-backed ETFs continue to decline and, with this important part of the “paper” market still in sell mode, the recent bounce has been even more impressive. Asset managers, many of which trade gold through ETFs, continue to focus on US economic strength, rising bond yields and potentially another delay in peak rates as reasons for not getting involved.
In addition, the cost of funding a non-interest-paying precious metal position remains elevated and has been a significant driver behind the year-long reduction in gold positions held by asset managers. In recent updates, we have argued that this trend would likely continue until we see a clear trend towards lower rates and/or an upside break forcing a response from real money allocators. With that in mind, it is interesting to note that we have yet to see a ‘fear of missing out’ (FOMO) buying response from asset managers, potentially adding further momentum to the rally when that changes.
Spot gold (XAUUSD) only paused for a short while at resistance around 1,946 before shooting higher towards even stronger resistance around 1,985. Failure to trigger a long overdue consolidation and correction back down towards 1946 could see prices move higher to eventually challenge resistance around $2075, the nominal record high from 2020. At this point, a correction is likely to be meet with fresh buying demand ahead of $1950 and especially the 200-day moving average, last at $1930.
The recent aggressive slump across the energy sector amid surging bond yields and the strong dollar accelerating demand worries has been almost fully reversed during the past couple of weeks as traders try to gauge the potential impact on supply from a widening conflict in the Middle East.
While the macroeconomic outlook remains challenged and demand shows signs of softening, the prospect of a geopolitical-led supply disruption and continued production restraint from OPEC+ will support prices in the weeks ahead. However, it is also clear from the price action this past week that it is exceedingly difficult to price the level of geopolitical premium and it has led to some volatile trading with buyers lacking the conviction to hold onto recent established longs.
With the US potentially recommitting to its sanctions against Iran after turning a blind eye for months – during which time production surged by around 700,000 barrels a day – the market was relieved by news that sanctions against Venezuela were going to be eased. However, following years of sanctions, the country’s ability to ramp up production is limited with analysts only seeing the potential for a relatively small 200,000 barrels per day increase within the next six months.
While the upside potential remains impossible to predict, the only thing we can be certain about is the existence of a floor beneath the market. Having fought so hard to support the price, and in the process giving up revenues, Saudi Arabia and its Middle East neighbors are unlikely to accept much lower prices. This leads us to believe support in WTI and Brent has been established and will be defended ahead of $80 and, barring any disruptions, the upside for now seems equally limited while the bear steepening of the US yield curve continues to raise recession concerns. With that in mind, Brent is likely to settle into a mid-80’s to mid-$90s range, an area we for now would categorize as being a sweet spot, not too cold for producers and not too hot for consumers.
Wheat, corn and soybean futures in Chicago have seen a strong rebound this past week with prices reaching one-month highs. Following a prolonged period of weakness, prices are now being supported by dry weather potentially hurting the production outlook in South America and Australia. While both Australia and Argentina have recently seen wheat production forecasts being downgraded, the global supply outlook remains robust with the International Grains Council (IGC) raising its forecast for global wheat production in 2023/24 season with upward revisions for Ukraine, Russia, and the US more than offsetting a deteriorating outlook in Australia.
It also worth pointing out that months of price weakness has resulted in net short positions being held by speculators such as hedge funds in corn and wheat, and any change in the technical and/or fundamental outlook may drive an oversized price reaction as positions are being adjusted.
Arabica coffee trades up 12.4% on the month, and following months of weakness during which time hedge funds built a sizeable net short position, the market has found its footing after establishing a double bottom around $1.45/lb. In addition, both Arabica and Robusta futures have been supported by a drop in exchange monitored inventories. Arabica coffee inventories monitored by the ICE Exchange has fallen to 422k bags, not far from the two-decade low of 385k bags seen this time last year.
EU TTF Natural Gas continue to trade near €50/MWh on fears of a wider Middle East conflict that could impact global flows ahead of the critical winter peak demand season. The Israeli-Hamas conflict has so far led to the shutdown of a major Israeli gas field supplying Egypt, raising questions over liquefied natural gas exports from the North African nation. However, with inventories near full the February TTF contract, the peak winter demand contract, only trades six euros above spot with supply concerns still relatively muted.
Platinum trades around $900 with its discount to gold reaching a record $1088 per ounce on Friday, more than 200 dollars above the average seen so far this year, and it highlights how investor interest has been directed towards gold but also the potential for a catchup rally given the outlook for tight platinum supplies in the coming years.
HG Copper and other industrial metals remain under pressure amid concerns about the medium-term outlook for demand growth in China and the rest of the world. Driving the current weakness has been a recent rise in exchange monitored stocks pointing to ample supply - a view being supported by a rising contango, and together with the current renminbi weakness, the short-term outlook looks challenged. We are watching key support in the $3.54/55 per pound area with a break below potentially fuelling a sell-off lower with no clear support until around the $3.24/14 area.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
