Head of Commodity Strategy
Summary: The commodity sector has started December with a focus on two major developments driving energy and metals in opposite directions. Crude oil has slumped while copper at the other end has climbed with the difference being driven by diverging growth expectations in China and the rest of the world
The commodity sector started December with a focus on two major developments driving energy and metals in opposite directions. Crude oil has slumped by more than 10% while copper at the other end has climbed 3% with the difference being driven by diverging growth expectations in China and the rest of the world. Growing concerns about the economic outlook for the US, Europe and elsewhere have triggered an exodus out of long-held positions benefitting from higher energy prices while the easing of strict virus curbs in China has given a boost to China-centric commodities from copper and iron ore to soybeans.
Next week the US Federal Reserve is widely expected to deliver a 0.5% rate hike, thereby ending a run of four 0.75% increases. The meeting comes at a time when the market increasingly has become worried about the economic outlook heading into 2023. A development that has driven a gold and silver supportive drop in US ten-year yields back to 3.5%, while the yield curve inversion has reached another 40-year extreme. The agriculture sector meanwhile trades softer on the month with gains in soybeans and sugar being more than offset by losses in wheat, coffee and livestock.
While the energy sector traded lower on concerns about the global economic growth outlook, industrial metals took comfort from the potential for an economic rebound in China, the world’s biggest consumer of metals, after the country continued to loosen Covid-19 controls while rolling out several measures designated to support the beleaguered property sector.
The Bloomberg Industrial metals index trades up 5% on the month so far with gains being led by zinc and copper with iron ore also seeing a strong rebound. While Dr. Copper increasingly in recent years have responded to the health of the Chinese economy, more than the global economy, the strength seen this past month remains impressive. Not least considering an expected supply surplus next year as mine supply is expected to increase and the global economy is expected to go through a soft patch.
However, the market is currently behaving as if the mentioned increase in mine supply may end up weaker than expected, and if that turns out to be correct, the market will instead look towards an emerging supply deficit in the following years supporting prices as renewables related demand picks up speed across the world. Exchange monitored stock levels in New York, London and Shanghai remain near a multi-year low and without the expected increase in mine supply, the shortfall may emerge sooner than currently being priced into the market.
For the second time in a month, HG copper has returned to challenge resistance around the 200-day moving average, currently at $3.925 per pound, with a break above raising the prospect for the metal breaking back above $4, a level that provided support for more than year up until June when renewed China lockdowns saw it tumble below.
The benchmark wheat futures contract traded in Chicago briefly touched the lowest level since October 2021 before finding support around $7.25 per bushel. The Bloomberg wheat index is currently down close to 10% on the year, after surging around 65% back in March when Russia’s invasion of Ukraine led the panic buying from consumers worried about supply disruptions.
The price weakness seen since October has been driven by a better-than-expected production outcome from the Northern Hemisphere harvest, especially from Russia. In addition, Ukraine grain export corridor has provided a great deal of relief regarding the availability of high protein wheat for human consumption. Despite floods, Australia is expected to produce a bumper year of crops including record wheat production. All developments posing tough conditions for US exporters already dealing with reduced competitiveness from the strong dollar. Despite the end of year weakness, the price of Chicago wheat remains around a third above the recent average. Soybeans meanwhile has been supported by strong demand led by top importer China, with the prospect for a reopening adding some additional support this past week.
Demand for gas is spiking with the arrival of unseasonably wintry weather in Northwestern Europe likely to spread into continental Europe next week. However, a very mild autumn and start to the winter not only helped delay the beginning of the withdrawal season but also helped ensure a rapid inventory buildup. As a result, European gas inventories at 1,000 TWh are currently 30% above the level seen this time last year.
While elevated storage levels will provide a buffer, they are nowhere near sufficient to get Europe through what may turn out to be a colder than normal winter. With that in mind imports from Norway and via LNG needs to remain elevated and following months of demand weakness from China, easing lockdowns may increase competition for LNG from Asian buyers. Much therefore hinges on consumers’ ability to keep demand in check, primarily by reducing heating in order to conserve supplies.
Following a period of stable trading around €100/MWh, Dutch TTF benchmark gas has moved higher to trade around €140/MWh, but still well below the panic levels above €300 that were reached around August time when Russia cut supplies through its major pipelines supplying gas to Europe. Power generation from wind turbines meanwhile is creating a great deal of volatility given its unpredictability. The need for higher gas usage when the wind speed slows has seen the cost of power surge higher during the past couple of weeks. An example being one-month German power which briefly traded above €400/MWh this week, a doubling in price during a two-week period.
Crude oil dropped to a one-year low with Brent crude briefly trading below $76 and WTI below $72, a loss of more than 10% so far this month. A weakening macroeconomic outlook which has seen the US yield curve inversion extend to levels signaling an incoming recession, has overshadowed the EU embargo on Russian oil and the prospect of a pickup in demand in China as lockdowns continue to ease. Short-term technical traders looking to squeeze existing longs remain in control as the overall level of participation continues to fall ahead of yearend. Next week Russia will announce how it intend to counter the introduced price cap with the risk of a production cut potentially adding fresh support to the market ahead of what looks like a challenging 2023 where supply worries in our opinion will keep prices elevated, despite the risk of lower demand.
Precious metals led by silver, given its link to rising industrial metals, trade up on the month supported by falling treasury yields and a weaker dollar amid worries about an incoming economic slowdown. The market will focus on next Wednesday’s FOMC meeting, and prior to that the release of November CPI data on Tuesday. The metals have both seen a shift in sentiment during the past month with the selling into strength strategy, adopted for months, being replaced by one of buying into strength. In gold we will be looking out for a challenge at key resistance at $1808 with a break setting up the potential for a further gain into 2023.
This week we published Saxo’s annual batch of Outrageous Predictions, titled “2023: The War Economy” and among the ten OP’s we included one that argues that under an extreme set of circumstances, gold could reach $3,000 per ounce in 2023.
Enjoy
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
