WCU: Precious metals defying rising real yields
Head of Commodity Strategy
Summary: The commodity sector traded higher for a fifth week with the Bloomberg Commodity Index trading near the seven-year reached last October. Gains were driven by industrial metals with the LMEX Index hitting a record, driven by Chinese stimulus and falling global inventories. Oil consolidated after hitting a seven-year high while precious metals continued to surprise the market with surging silver and platinum supporting gold which reached a two-month high.
The commodity sector traded higher for a fifth week with the Bloomberg Commodity Index trading near the seven-year high reached in October 2021. Gains were driven by industrial metals with the LMEX Index – tracking the six main industrial metal contracts traded in London – hitting a record, driven by Chinese stimulus and falling global inventories. Precious metals continued to surprise the market with surging silver and platinum supporting gold which reached a two-month high. This despite the headwinds being created by the continued surge in US real yields as the market prices in aggressive Fed action over the coming months in order to curb inflation.
The energy sector traded mixed with crude oil extending its weekly run of gains to five, but after hitting a fresh seven-year high, some profit-taking and consolidation started to emerge which potentially could trigger a near-term and long-overdue correction. However, with underlying fundamentals being as strong as they are, the risk of a major setback seems limited. Natural gas meanwhile slumped on either side of the Atlantic on mild weather developments in the USA and strong LNG arrivals in Europe offsetting the price spike risk associated with Russia’s aggressive behavior along the Ukraine border.
The Bloomberg agriculture index broke higher to reach the highest level since 2016 with gains being led by wheat, soybeans, sugar and cotton. Wheat futures in Chicago and Paris advanced with the market worrying about the impact on supplies from heightened tensions between Russia and Ukraine, two of the world’s biggest shippers of the grain. Along with robust demand from countries such as Egypt, Turkey, Algeria, as well as China, a disruption could trigger a further price spike.
Other food commodities such as sugar and soybeans are being supported by surging fuel prices as it increases the appeal of turning more agriculture commodities into biofuels. Following months of speculative selling from funds cutting long positions, the raw sugar future traded in New York posted its biggest weekly advance since December while soybean oil in Chicago and palm oil futures in Malaysia are trading near a record high.
These developments combined with surging cost of fertilizers have raised the prospect for the highest food inflation in 14 years not coming down anytime soon, thereby adding additional stress on the economies of large importers in the Middle East and North Africa. In Europe, the energy crisis is leading the continent directly to a fertilizer crisis where punitively high prices or even lack of supply may force farmers either to use less nutrients, leading to lower production, or pass on the costs to the consumer. Europe has been the hardest hit by fertilizer-plant cutbacks driven by soaring costs of gas, a key input to the production process.
Precious metals headed for a second straight weekly gain with gold continuing to find bids after above $1830, this despite seeing US ten-year real yields rising to a fresh cycle high on Friday at -0.54%. The latest move happened in response to the market, wrongly in our opinion, are pricing in lower inflation expectations in the belief a succession of rate hikes signaled by the US Federal Reserve will do enough to curb inflation. All of these developments occurring while short covering lifted bonds due to rising risk adversity in the stock market together with geo-political concerns in Europe. The star performers across the commodity sector this past week were silver and platinum, both rising by more than 7% as they played catch up with gold after weeks of underperformance. Gold will looking for support at $1830 and resistance at $1850 followed by the November peak at $1877.
The industrial metals sector jumped to a record high on the prospect of rapidly declining inventories, supply disruptions and the prospect for Chinese stimulus raising the potential for a renewed upside push. Nickel led from the front once again, touching $24k a ton for the first time in more than a decade while tin, the smallest metal in volume terms, hit a fresh record high. Nickel, one of several metals including lithium and cobalt vital for making batteries in electric cars, has not seen this level of tightness since 2007 as stockpiles at warehouses monitored by the exchanges in London and Shanghai continue to decline. In addition, tensions over Ukraine have also raised the potential for disruptions to exports from Russia, a major nickel producer together with Indonesia.
Copper traded sideways following a recent failed upside attempt. We maintain a bullish outlook for copper, driven by the prospect for rising demand towards electrification, tight supplies and signs China is stepping up its policy response to support a slowing economy, thereby off-setting recent macro risks, especially those stemming from China’s beleaguered property sector.
Crude oil’s month-long rally showed signs of slowing after Brent crude oil found resistance ahead of the key $90-dollar a barrel price, and after US crude oil inventories rose for the first time in eight weeks and the White House talked up the prospect of accelerating releases from its strategic reserves. The market, however, remains very tight with supply struggling to keep up a demand that has seen a limited impact from surging Omicron cases around the world.
The market is in particular worried that the OPEC+ group, despite signaling higher output, will struggle to meet those targets. For several months now we have seen overcompliance from the group as the 400,000 barrels per day of monthly increases was not met, especially due to problems in Nigeria and Angola. However, more recently production challenges have seen several other countries, including Russia, fall short of their targets.
The rising gap between OPEC+ crude oil quotas and actual production has been the main driver and with the outlook pointing towards rising demand and falling spare capacity, the risk of reaching 100-dollar barrel oil later in the year continues to grow. A risk that was highlighted by the IEA in their latest Oil Market Report for January. In it the group said the market looked tighter than previously thought, with demand proving resilient to omicron.
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.
In the short term, as mentioned, the market needs to consolidate its recent strong gains, and with that in mind the risk of a small setback has emerged. Brent crude – as well as WTI – has several support levels to choose from, with the first at $85.50 followed by $83, ahead of the first major support at $81.80, the 38.2% retracement of the latest surge higher. An unlikely setback of this magnitude will likely be taken as an opportunity to accumulate fresh long positions.
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