Head of Commodity Strategy
Summary: Turmoil and roller coaster markets have become the new normal in stocks and bonds while commodities continue their ascent. The Bloomberg Commodity Spot Index trades up more than 11% following seven consecutive weeks of gains as it continues to reach fresh record highs. The gains have been driven by a continued rally in energy with US natural gas up 40% while crude oil, one of the most important inputs for the global economy, trades higher by close to 25%.
Turmoil and roller coaster markets have become the new normal in stocks and bonds while commodities continue their ascent. The Bloomberg Commodity Spot Index, which tracks the front month performance of 24 major futures contracts, trades up more than 11% following seven consecutive weeks of gains as it continues to reach fresh record highs. The gains, as clearly shown below, have been driven by a continued rally in energy with US natural gas up 40% while crude oil, one of the most important inputs for the global economy, trades higher by close to 25%.
The past week continued to produce whipsaw action in the stock market, thereby showing us that this market is out of balance and can go anywhere in the short term. We believe the downside risk remains the greatest, not least considering the change in tone at central banks around the world. Most recently at the ECB which has finally caved into the rising threat of inflation leading to a capitulation on its former resolute dovish stance and accepting the need to bring forward rate hikes.
European bond yields spiked on the news and with the US losing its yield advantage it helped open the floodgates to short euro covering, thereby supporting the longest run of dollar losses since April. A weaker dollar is generally commodity positive while supporting Emerging Market growth which is more commodity intensive than Developed Market growth.
World food prices rebounded in January according to the UN FAO’s food price index, which tracks a basket of 95 globally traded food commodities. The index moved closer to the record high from 2011, a year when surging prices of cereals and rising cost of living in general helped trigger the Arab Spring. However, taking the base effect into consideration, the year-on-year rise slowed to 19.5% from the 40% recorded last May.
Higher food prices during the past year have been driven by a combination of a post-pandemic economic recovery raising demand, a troubled weather year, and the prospect for another season’s production being interrupted by La Ninã developments, Covid outbreaks challenging supply chains, labour shortages and more recently, rising production costs via surging fertilizer prices and rising cost of fuels, such as diesel.
Vegetable oils led by soybeans and palm oil have topped the table this year with support coming from strong demand for plant-based fuels as crude oil continues to rally. Palm oil futures traded in Malaysia hit a record this past week on concerns over tight supply after top grower Indonesia announced export curbs to control domestic prices. Soybeans were supported by continued downgrades to Brazilian crop estimates due to adverse weather while political unrest in Argentina, the world’s largest exporter of soybean products, also helped create nervous trading.
Staying with export curbs, Russia announced a two-month ban on ammonium nitrate exports to ensure a successful domestic sowing season with ample supply. The price of ammonium nitrate has seen a four-fold increase during the past year amid surging natural gas, commonly used as feedstock to produce two nitrogen-based fertilizers – ammonia and urea. With Russia being one of the world’s largest exporters, the impact will be felt not only in Europe but also in Ukraine, a major producer of high-quality wheat, corn, and edible oils.
Crude oil: As mentioned, the energy sector continues to lead the broad rally in commodities with crude oil’s current unstoppable rally extending into a seventh week. Both WTI and Brent reached new cycle highs above $90 with rising front-month spreads signaling increased tightness. The combination of tight supply, inflation, the weaker dollar and the current turmoil in stocks and bonds are likely to have driven increased demand from paper investors, with asset managers and speculators at large funds seeking a haven to help weather the storm currently blowing across their traditional investment portfolios.
In addition, support continues to be provided by geopolitical tensions, freezing weather in Texas which has hit some supply, and the latest weekly EIA stock report showing another drop in US crude inventories with production now down some 300k barrels per day since December. Fundamental data pointing to a fast-tightening market was supported this week after OPEC+ agreed to proceed with another 400k barrels per day increase while at the same time failing to address the growing gap between quotas and what is being produced.
The oil bears – if there is anyone left – may view this as a sign that OPEC+ stick to their belief oil markets will be ample supplied once we get through the peak winter-related demand. The oil bulls meanwhile have read the lack of action as a sign that no action can currently be taken with just a few producers being able to ramp up production. Any unilateral decision by countries like Saudi Arabia and the UAE to temporarily ramp up production may end up leaving a wafer-thin level of spare capacity and with that a risk of spiking prices into an unforeseen supply disruption.
Global oil demand is not expected to peak anytime soon and that will add further pressure to available spare capacity, which is already being reduced monthly, thereby raising the risk of even higher prices. This supports our long-term bullish view on the oil market as it will be facing years of under investment with oil majors diverging some of their already-reduced capital expenditures towards low-carbon energy production. No doubt both WTI and Brent increasingly need to consolidate their strong gains but as long the 21-day moving average is not broken, the potential for further upside gains remain.
Gold stabilized following the late FOMC-driven January tumble and during the week it settled into a range around $1800 with bids continuing to emerge on any weakness below. Silver meanwhile held above key support at $22 but has so far been struggling to find the momentum that supported a strong period of outperformance at the start of January. Weighing on the market were rising bond yields after the European Central Bank and the Bank of England joined the Federal Reserve in expressing a more hawkish view on interest rates to combat inflation. Inadvertently, the hawkish signals from Europe helped send the euro sharply higher against the dollar, with the greenback heading for its biggest weekly drop since November 2020. The biggest challenged came on Friday after a much stronger than expected US report helped send bond yields sharply higher while the dollar managed to claw back some of its earlier losses.
Apart from robust demand from central banks, we maintain a patient but long-term bullish outlook for precious metals:
The short-term technical outlook remains neutral with firm support established down towards $1780 while a break above $1825 is needed to attract renewed buying momentum towards $1854 and ultimately the November high at $1877.
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