WCU: Commodities await the greenback’s fate

From an EM growth and demand perspective, the narrative is arguably that global markets will remain in a fragile state until the Fed backs off its quantitative tightening and rate hiking regime, with the risk of a real crisis linked to EMs' overindulgence in borrowing USD since the global financial crisis. 

Not all commodities received a boost from the weaker dollar. In the grain sector covering the key crops of wheat, corn and soybeans, the market has turned its attention to the US harvest Following a troubled growing season in Europe, CIS and Australia, with the US expected to yield ample supply to offset losses elsewhere. Adding to this, the ongoing trade dispute with China has sharply reduced demand from the most important destination for US-produced soybeans. 

Overall, the Bloomberg Commodity Index covering 25 major commodities traded higher for the first time in three weeks with the aforementioned losses being more than offset by gains in crude oil and products as well as industrial metals. After a few weeks of heavy selling, industrial metals (led by zinc and aluminium) reacted positively to signs of emerging demand from China. Precious metals traded higher but have yet to break any significant levels that may trigger a rethink among speculative traders who currently hold a record short position three times the size of the previous record set in December 2015. 

Crude oil recovered more than half of the July-August sell-off. This came as the market’s attention turned from the potential longer-term impact of lower EM growth to the short-term impact of US sanctions against Iran. 

Tanker tracking data from Platts show that Iran’s crude oil exports have fallen sharply during the first half of August. During this time they saw 1.68 million barrels/day being exported, some 640,000 b/d below the average for July. This will undoubtedly raise pressure on the remaining Opec members and also raise the question whether they will be able to meet the potential shortfall – not only from Iran but also from Venezuela which continues to deteriorate. 

Hedge funds have continued to reduce bullish oil bets in recent weeks and since hitting a record above one million lots (one billion barrels) on March 30, the combined long in WTI and Brent has now seen a 37% reduction. Given its role as the global benchmark, Brent crude oil has seen the biggest reduction to 336,000 lots, down 47% since March.  

During the July to August sell-off it is worth noting that both long and surprisingly also short positions were reduced. The gross-short in WTI and Brent remains close to the lowest in five-years and this highlights the limited selling appetite ahead of the expected Iranian supply drop. 

We maintain the view that Brent crude oil is likely to remain range-bound within a $70 to $80/barrel range. With the short-term focus switching to supply we see some additional upside potential towards $80/b. 

The combination of ample supply, a speculative attack, and a Brazilian real in freefall at one point helped drive the price of Arabica coffee below $1/lb for the first time in 12 years. For the same reasons, sugar dropped below 10 cents/lb for the first time in 10 years. Using the Bloomberg Commodity coffee index, which includes the roll yield, we find Arabica coffee down by 24% year-to-date and since the 2014 peak it has lost close to 70% of its value.

Ample supply from Brazil, the world’s biggest producer of high-quality beans, together with a significant recent 10% drop in the value of the Brazilian real on the election and general EM nervousness has done most of the damage to price. Additional to this, we have speculative selling from hedge funds which has further suppressed the price. Currently funds hold a record short position of a staggering 1.7 million tons or 28% of the expected global production for 2018-19. As long the technical or fundamental outlook does not improve, they are unlikely to buy back their short positions and thereby support the price. 

Fundamental support, however may start to emerge from reports that have begun to highlight some drought risk to the next crop in Brazil. An unusually early Brazilian coffee flowering has raised some concerns as this phase requires water to support the process towards developing cherries. The dry season normally extends until the second half of September so the next few weeks could be quite crucial.