Commodity Weekly: Volatile start to 2020

Global commodities could, as the first few weeks highlight, face a potentially volatile 2020 given the combination of ongoing geopolitical tensions, climate change and inflationary pressures. While global growth and resulting demand for key cyclical commodities remains stable, we see the supply side facing several challenges due to social unrest and climate change.

Climate change will be the key focus in our Q1 Outlook due to be published on January 23. For commodities, we see these challenges manifest themselves through increased weather volatility leading to intense droughts, floods, heatwaves and wildfires leading to an increase in the rate of soil loss and land degradation.

Led by vegetable oils, meat and dairy global food prices have shown a steady rise during the past year. The UN FAO’s World Food Price Index which tracks 73 food commodities across five major groups, has risen 12.5% during the past year to reach a five-year high.

U.S. priced natural gas recovered after reaching $2.08/therm, a record low for this time of year and due to unusually mild weather hurting demand at a time of strong production. It nevertheless managed to stay supported despite the smallest weekly storage draw in 11 years. It is not too late for a late winter scare to support the price, especially considering the combination of the mentioned low price level and speculators holding a record short position.

Arabica coffee also showed signs of finding support after retracing half of its dramatic 55% rally witnessed between October and December last year. The rally back then has led to a sudden,  surprise jump in exchange-certified stockpiles thereby removing the support which led to the strong rally. The outlook for 2020 remains supportive with a global deficit expected to underpin the price. But for now, the market is once again under pressure from short-sellers who, due to the forward price curve structure, can pick up a 1-year carry on holding a short futures position of more than 10%.

Crude oil’s month long rally came to an abrupt end this week. The slump that followed US-Iran spike above $70/b on Brent crude oil, the global benchmark, was in our opinion driven by several factors. In the run up to the November U.S. election the appetite for another costly and most likely non-winnable Middle East war seems low. Not least considering the potential damage it would inflict on Trump voters through higher gasoline prices and falling stock markets.

Saudi Arabia and its GCC friends have and will undoubtedly continue to apply a lot of pressure on the U.S. in order to avoid an escalation which would hurt economic growth and sentiment across the region. Not least the UAE, which is currently preparing to host Expo Dubai 2020 from October to April next year. It is expected to attract more than 25 million visitors from over 192 countries.

Crude oil is currently being held down by rising non-OPEC production led by the U.S and a potential disruption to supply could be mitigated by the release of strategic reserves held by the U.S., China, Saudi Arabia and IEA member countries.

Most of the Middle Eastern oil travels east not west with China being the biggest buyer. Iran, hit by sanctions, receives most of its oil revenue from China and any obstruction or risk to the safe passage from the Arabian Gulf would hurt them as well.

Finally, speculative buying of Brent and WTI crude oil since the OPEC+ meeting on December 6 reached 213 million barrels in the week to December 31. The sharp sell-off, once tensions eased, probably got exaggerated by the need from those holding loss making positions to reduce. 

Having surrendered half the October-to-January gains, crude oil is likely to settle into a range with Brent crude oil, given the risk of another flareup, likely to find support between $64/b and $62/b. During Q4 we focused on a $60/b to $65/b range but following the agreement and adaption of further OPEC+ reductions, we raised that range by three dollars.

Providing the geopolitical stage stays quiet, the short-term market direction is likely to be determined by the weekly U.S. stock reports, economic leading indicators, U.S. – China trade news and monthly oil market reports from EIA, OPEC and IEA, with the next all due between January 14 and 16. 

After racing higher this past week, and almost reaching our 2020 target at $1625/oz in three days, gold may now spend most of the first quarter consolidating. From a technical perspective preferably above $1510/oz and no lower than $1450/oz, before eventually moving higher later in the year. The short-term consolidation risks also takes into consideration the near record level of long hedge fund positions, which in the short-term could act as a drag on the price through long liquidation.

Geopolitical events such as the early January US-Iran standoff has supported gold but only for relatively short period of time. Apart from the underlying support from money managers using gold as a portfolio insurance the yellow metal need support from some of our 2020 expectations in order to climb further. They are: Federal Reserve cutting rates by more than expected, rising inflation concerns through higher input costs from energy and food, continued central bank buying (de-dollarization), a weaker dollar and not least multiple event risks culminating in the November US Presidential election.