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Commodity sector supported by peak rates, tight supply focus

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Ole Hansen

Head of Commodity Strategy

Summary:  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.


Stagflation could reignite the precious metal sector

The strength we forecast, and which materialised across key commodities during Q3, looks set to extend into the final quarter, as a weakening economic outlook in Europe and the US, and to a lesser extent China, continues to be more than offset by supply concerns. Not least in the energy sector, where the OPEC+ group of producer's active supply management has proven extraordinarily successful, thereby creating an elevated and price-supportive level of tightness across crude and fuel-based products.

Precious metals

Precious metals performed well during the third quarter, with gold trading close to unchanged despite the stronger dollar, a big jump in US Treasury yields and emerging expectations that the FOMC will keep official rates higher for longer. However, given the elevated risk that economies on both sides of the Atlantic may move towards stagflation, we see the potential for a strong quarter ahead for investment metals, such as gold, silver and potentially also platinum, given its current cheapness to gold.

The timing of a precious metal-supportive peak rate scenario remains unclear while central banks continued to battle inflation, a situation made more challenging by the recent rally across the energy sector. However, as Althea Spinozzi writes in her bond market outlook, sticky inflation may not mean that we will see more interest rate hikes. The increments of hikes have already become smaller, and some central banks have been pausing hikes at some meetings. That means we are approaching the end of the hiking cycle or that we may be done with hikes already.

What will follow is a fine-tuning of monetary policies, trying to maintain a hawkish bias as inflation remains above central banks’ targets. The horizon, however, will be clouded with a deceleration of economic activity and geopolitical risk, which will build the case for a bull market, not only in bonds but also in precious metals, as yields stabilise and investors increasingly move their focus towards the need for lower real yields, which in the US, given the current outlook, have reached unsustainable high levels.

We maintain a patiently bullish view on gold, and with that also silver and platinum, and we see the yellow metal eventually reaching a fresh record in the coming months. The timing for a fresh push to the upside, however, will remain very US economic data-dependent, as we wait for the FOMC to turn its focus from rate hikes to cuts, and during this time, as seen during the past quarter, we are likely to see continued choppy trade action.

Industrial metals

Industrial metals will continue to focus on the Chinese government’s effort to stabilise the economy, its property sector and currency, while demand for so-called green metals continues to provide a soft floor under prices, as demand continues to rise as the electrification of the world gathers momentum.

The lack of big mining projects to ensure a steady flow of future supply continues to receive attention from long-term focused investors, as it supports our structural bullish outlook, driven by rising demand for green transformation metals, especially copper, and mining companies facing rising cash costs driven by higher input prices due to higher diesel and labour costs, lower ore grades, rising regulatory costs and government intervention, and significantly, climate change causing disruptions from flooding to droughts. This development is already on display with exchange-monitored stock levels of key mined metals remaining near a multi-year low.

We maintain a long-term positive outlook for copper, currently stuck in a wide $3.25 to $4.25 range. In the short-term, movements in the Chinese yuan will provide most of the directional price input, before prices eventually move higher once the tight supply outlook and robust electrification demand take over and drive prices towards a fresh record, sometime in the new year.

Crude oil and fuel products

The emerging risk of stagflation that we see supporting investment metals has been strengthened by the OPEC+ group of producers' successful attempt to steer energy prices sharply higher. Faced with prices too low for comfort, key crude producers led by Saudi Arabia have since April been tightening the energy market through lower production. However, after first saying the need for a stable and balanced market was the reason, the market has increasingly realised that the main objective is higher prices to optimise revenues.

The latest surge back towards USD 100 Brent was triggered by the combination of Russia and Saudi Arabia announcing an extension of voluntary cuts to yearend, and OPEC in their monthly report saying the global oil market may experience a shortfall of 3.3 million barrels per day in the fourth quarter. While the IEA sees a more moderate but still worrying supply deficit, the outlook for crude prices has turned decisively more supportive. The current tightness has increasingly been driven by very tight diesel stocks after Russian and Middle East producers cut their supply of diesel-rich crude. The risk of higher prices in Q4 cannot be ruled out, and our price outlook needs to reflect the fact that the OPEC+ focus is more about price optimisation than price stability, and the short-term risk of Brent moving towards, and briefly above, USD 100 cannot be ruled out.

However, while OPEC can control supply and inadvertently raise the level of spare capacity -  something that rarely goes hand in hand with higher prices - they have limited influence on demand, and with inflationary pressures from higher energy prices on the rise again and the economic outlook challenged, we see demand worries eventually becoming the focus again. Only at that point will the market start searching for the floor that an increasingly assertive OPEC will try to defend, potentially somewhere in the mid-80’s.

Agriculture

While global food prices, according to the UN FAO Global Food Price Index, trade down 12% year over year, the third quarter saw a distinctive performance gap emerge within the agriculture sector, as the grain and soybean sector traded lower while the softs sector gain was second behind the energy sector. Corn and wheat futures in Chicago traded lower, following a growing season that yielded a better production than originally feared, thereby helping offset continued worries about Ukraine wheat supplies. Looking ahead, the focus in the coming months will turn to weather developments across the southern hemisphere, not least in Australia where La Niña hot weather concerns are already on the rise, and South America, which increasingly has replaced the US as the main supplier of corn and soybeans to China, the world’s top importer. The softs sector meanwhile has and will likely continue to be supported by hot weather concerns across Asia, concerns that have already led to export curbs of sugar and rice, while the Florida production of orange juice has been decimated.

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