Head of Commodity Strategy
Summary: The commodity sector traded lower in September with the weakness being driven by growth dependent sectors, like energy and industrial metals, in response to a deteriorating outlook for global growth. In addition, we have witnessed a month of turmoil across financial markets driven by heightened geopolitical concerns together with an FOMC-driven dollar and yield surge raising concerns about financial stability. However, tight supply of several key commodities, through lack of investments, sanctions or weather continues to provide some underlying support.
The commodity sector traded lower by around 7% in September with the weakness being driven by growth dependent sectors, like energy and industrial metals, in response to a deteriorating outlook for global growth. This deterioration was led by China’s weakness, due to prolonged lockdowns, and Europe remaining embroiled in a historic energy crisis. Adding to this, we have witnessed a month of turmoil across financial markets driven by a surging dollar and traders sending bond yields sharply higher in anticipation of further rate hikes from central banks, led by the US Federal Reserve.
With the dollar’s real effective exchange at its strongest level since 1986 and with the yield on US Treasuries surging higher, the impact on global bond markets is clear as yields rise and currencies slumping – thereby creating a level of heightened instability in countries from the United Kingdom and within the European Union to China and emerging markets where rates are being hiked (although local conditions are much weaker).
All developments that are rapidly driving us towards peak hawkishness in the US, from where the dollar and yields will plateau before heading lower again. However, whether something breaks before the FOMC changes its tone remains to be seen but the risk to financial stability, as seen in the UK this past week, is real and one that may impact the outlook for several commodities, especially investment metals such as gold and silver.
Our forecast for stable or potentially even higher prices led by pockets of strength in key commodities across all three sectors of energy, metals and agriculture will be driven by sanctions, upstream cost inflation, adverse weather, low investment appetite and continued tightness across many key commodities from diesel and gasoline to grains and industrial metals.
Having seen individual commodities correct from their recent peaks – by anything from 12% for key food commodities, including corn, wheat, coffee and sugar, to 77% for nickel – the heavy selling, driven by growth and demand concerns, would usually reduce the level of tightness in the market. However, looking at the spread between the front futures contract and the one expiring in 12 months, we continue to find most markets still trading in backwardation – a measure of how aggressive traders are bidding up prices to ensure immediate delivery
While Russia is likely to produce a record wheat crop, Ukraine’s President Zelenskiy has warned that Russia is preparing the ground for an attempt to disrupt flows from Ukraine, another key supplier of high quality wheat to the global market. The December wheat contract traded in Chicago traded above $9 per bushel on Friday, well below the $13.63 per bushel panic peak seen in the aftermath of Russia’s invasion but still well above the sub-$6 per bushel average seen during the last half decade. Late on Friday after the publication of this update, the market was awaiting two key reports from the US Department of Agriculture – a quarterly stock report, which covers all major US grains, and a production update on all wheat varieties.
All developments that has led us to believe a low in crude oil could be found sooner rather than later with Brent then returning to a range closer to $95 than the current $85 per barrel.
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