Head of Commodity Strategy
Summary: The commodity sector is having a mixed but overall strong month supported by a weaker dollar following the US CPI surprise and China easing some of its heavy-handed Covid rules. Industrial and precious metals leading from the front while the grains sector led by wheat trades lower. Among the top performers we find gold, silver and copper, all showing signs of breaking higher, thereby potentially forcing a change in a sell-into-strength strategy that has been the main focus by traders in recent months
Occasionally, traders across commodities and financial markets receive news that triggers instant and historic movements. This past week will enter the history books – courtesy of a slightly softer than expected US CPI for October, sending markets into a frenzy in the belief that the US Federal Reserve may finally have received the news needed to slow down its pace of tightening.
The October U.S. consumer price index increased less than expected after showing a 0.4 % rise on the month to 7.7% on a year ago basis. At the same time, core inflation – which is highly monitored by market participants – increased 0.3 % on the month and 6.3 % over the past twelve months. While both numbers came in 0.2% below expectations, this is still uncomfortably high for the U.S. Federal Reserve, but it seems to confirm that inflation is slowly slowing down in the United States.
The response from the markets was historic as US equities traded up by more than 5% while US ten-year yields dropped by 30 basis points. A slump in the dollar added to the positive sentiment across markets, especially for commodities where metals extended recent strong gains and crude oil reversed earlier losses. The Japanese yen – the most shorted currency against the dollar – saw the biggest one-day gain since 1998, while the euro built upon an already recovering sentiment by surging to a three-month high in the €1.0350 area.
Weeks of speculation that China was considering easing some of its heavy-handed Covid rules finally came to fruition on Friday when China’s health authorities released 20 new guidelines. The key measures included reducing the number of quarantine days, relaxing some centralised quarantine rules to quarantining at home, limiting PCR testing, prohibiting excessively extending lockdowns, promoting vaccination and treatments and prohibiting local authorities from shutting down production, schools and transportation without proper approval.
The easing being implemented at a time where new cases are spiking sends a strong signal that China is finally moving towards a growth friendly stance and commodities responded accordingly. The industrial metal sector headed for its best two-week performance since March, leading to a +12% rally being led by copper – which surged higher to threaten the sell-into-rallies mentality that has prevailed for many months now.
As per the performance table above, it has generally been a strong start to November for the commodity sector. Industrial and precious metals leading from the front while the grains sector, despite the softer dollar, trades lower. The main driver of the weakness being wheat, which saw prices slump in Chicago and Paris as expectations of higher world supplies weighing on the market. The U.S. Department of Agriculture, in its monthly supply-demand report (the World Agricultural Supply and Demand Estimates), saw world wheat stocks at 268 million tons, up slightly from its October outlook of 268 million tons and higher than analysts forecast for a small decline to 266.5 million tons. In addition, wheat prices were also pressured by the news Russia had ordered its troops out Kherson, potentially improving the prospect for an extension to the current Ukrainian safe corridor agreement once the existing one expires on November 19.
Gold is heading for its biggest weekly gain since March after the weaker-than-expected CPI print gave metals, including silver, a major boost from the subsequent drop in yields and the dollar. The yellow metal traded up 7% during the past two weeks after once again finding support in the $1615 area, now a triple bottom. Whether the break above resistance-turned-support at $1735 now signals a change in the trading behaviour among speculators from sell-into-strength to buy-on-weakness remains to be seen.
Supporting the underlying improvement in sentiment was the recent published Gold Demand Trends Q3 2022 update from the World Gold Council. The update outlined how central bank demand, despite seeing gold slump by 8%, reached a quarterly record of nearly 400 tons, thereby offsetting a 227 tons outflow from bullion-backed ETFs. Overall, the year-to-date demand increased 18% versus the same period in 2021, signalling a return to pre-pandemic levels.
Overall, we maintain our long-held bullish view. This is primarily driven by expectations of a major repricing when the market realises long-term inflation will settle at a higher level than the sub 3% currently being priced in. ETF investors – net sellers for months - and speculators in the futures market (having traded the market with a negative bias) now hold the key that could unlock further gains. Without support from these important segments of the market, gold and silver will continue to find most of the directional inspiration from movements in Treasury yields and the dollar. Expect some consolidation and potentially a recheck of support at $1735 with resistance at $1765 and $1789.
Copper traded near a five-month high, with the +12% gain during the past two weeks being supported by a weaker dollar and the prospect of China showing willingness to support economic growth by allowing Covid restrictions to be eased despite seeing infections increase to the highest level since April. With the global economic outlook still clouded by the prospect of recession hitting some economies, the potential for a sustained recovery at this stage is probably still too early to call. For now, we are seeing traders and investors responding to higher prices by reducing negative biased positions.
We maintain a long-term positive outlook on the industrial metal sector, given the expected increase in demand towards global electrification. With regards to copper – the so-called king of green metals – we expect that the prospect for a temporary increase in production capacity next year by miners around the world, most notably from Central and South America as well as Africa, will likely dampen the short-term prospect for a renewed surge to a fresh record high.
The copper intensive electrification of the world will continue to gather momentum, following a year of intense weather stress around the world and the need to reduce dependency of Russian produced energy from gas, oil and coal. But for power grids to be able to cope with the extra baseload, a massive amount of new copper intensive investments will be required over the coming years. In addition, we are already seeing producers like Chile, the world’s biggest supplier of copper, struggling to meet production targets amid declining ore grade quality and water shortages. China’s slowdown is viewed as temporary and the economic boost through stimulus measures are likely to focus on infrastructure and electrification – both areas that will require industrial metals.
HG copper has moved to within striking distance of a key area of resistance around $4, the break below which triggered the June slump. Just like gold, we expect the focus will turn to consolidation in order to discover whether the current supply and demand outlook is strong enough to support current levels.
Brent and WTI crude oil traded up on the week but remain stuck inside their established ranges, around $95 per barrel for Brent and $90 per barrel for WTI. While the softer CPI print supported prices due to an improved sentiment and the weaker dollar, the price was also buoyed by the mentioned easing of restrictions in China. A decisioni that may improve the growth outlook, thereby supporting a pickup in demand for raw materials, including crude oil.
While crude oil has been mostly rangebound since July, the fuel product market has continued to tighten as supplies in Europe and the US have become increasingly scarce – thereby driving up refinery margins for gasoline and distillate products such as diesel, heating oil and jet fuel. The focus in terms of tightness remains on the northern hemisphere product market where low stocks of diesel and heating oil continues to raise concerns. The market has been uprooted by the war in Ukraine and sanctions against Russia – a major supplier of refined products to Europe. In addition, the high cost for gas has supported increased switching activity from gas to other fuels, especially diesel and heating oil.
As long the product market remains this tight, the risk of seeing lower crude oil prices – despite recession concerns – seems to be low. We maintain our forecast for a price range in Brent for this quarter between $85 and $100, with the tightening product market, OPEC+ production cuts and upcoming EU sanctions against Russian oil increasingly skewing the risk to the upside.
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