Head of Commodity Strategy
Summary: Commodities suffered a broad but relatively small setback this past week, driven by a hawkish FOMC hurting risk sentiment and the combination of a long overdue correction across the energy sector, continued weakness in the grain market as the northern hemisphere harvest season end, and another setback across industrial metals. Precious metals led by silver where among the surprise winners in a week that saw bond yields spike and expectations for future rate cuts lowed, and we conclude that the breakdown in normal correlations is likely due to a market in search of a hedge against the FOMC failing to deliver a soft, as opposed to a hard, landing or even stagflation
Global Market Quick Take: Europe
Market update: Gold holds support on doubts about Fed’s soft-landing message
Commodities focused podcast: What does a Fed soft landing mean for commodities?
Commodities suffered a broad but relatively small setback this past week, driven by the combination of a long overdue correction across the energy sector, continued weakness in the grain market as the northern hemisphere harvest season ends – thereby reducing uncertainty about the outcome – and another setback across industrial metals. Above all, however, the US Federal Reserve hurt risk sentiment across markets after it delivered an expected pause in its aggressive rate hike campaign, while simultaneously forecasting considerably higher rates over 2024 and 2025 because of a resilient US economy, a strong labour market and sticky inflation, recently made worse by an OPEC-supported rise in energy prices.
The “dot plot” of rate projections still left the door open for one more hike before yearend, while the outlook for rate cuts in 2024 and 2025 was reduced by a half-percentage point. This signals that the Fed expects rates to stay higher for longer amid expectations of a soft landing, as opposed to a hard landing or stagflation. The general level of risk appetite received a knock from these projections, with the S&P 500 suffering its worst sell-off in six months, the dollar reaching a six-month high against a basket of major currencies, and the yields on US 2-year and 10-year Treasuries hitting a 2006 high. Traders in the short-term interest rate futures market reduced bets on the number of 25 basis-point rate cuts during H1-2024 to just one from around three last month.
The Bloomberg Commodity Index, which tracks a basket of 24 major commodity futures, traded lower by less than 1% with losses across most sectors being partly offset by precious metals, a very surprising winner on the week, not least given the headwinds from a stronger dollar and yields. Silver tops the table, a feat that is even more surprising given a challenging week for industrial metals, not least for copper – which dropped to the lower end of its long-established range amid rising stockpiles and a lack of additional China stimulus.
After hitting a record peak in June last year, the Bloomberg Commodity Index went through a year-long 28% decline that ended on May 31 when rising crude and fuel prices helped support a turnaround. During this time, falling commodity prices helped support central banks’ efforts to bring inflation under control. During the past month, however, the relentless rally across the energy sector – except natural gas – has seen the number of commodities adding to inflation concerns continue to rise, potentially supporting a sticky inflation outlook.
In our latest gold market update published after the market had responded to the FOMC ‘higher for longer’ message, we wrote about the reasons why precious metals are managing to trade higher despite the headwinds, which also include the rising opportunity cost of holding a non-interest paying investment like the yellow metal.
We conclude that the breakdown in normal correlations is likely due to a market in search of a hedge against the FOMC failing to deliver a soft, as opposed to a hard, landing or even stagflation. In a recent article in the Wall Street Journal, titled “Why a soft landing could prove elusive” Nick Timiraos, the reporter known as the Fed whisperer, writes that almost every hard landing looks at first like a soft landing. He also highlights four developments standing in the way of a soft landing:
The risk of stagflation or a hard landing was also expressed by former Treasury Secretary Summers who in an interview said that Federal Reserve policymakers are too optimistic with their latest set of economic projections, cautioning that they are at risk of being surprised by both faster inflation and weaker growth than they anticipate. Saxo’s strategy team agrees with this risk – which we have highlighted in several recent articles and explained in this podcast.
The current demand not only for gold, but also silver and platinum, as hedges against a soft-landing failure will likely continue in the coming months as the outlook for the US economy looks increasingly challenged. With that in mind, we maintain a patiently bullish view on the mentioned metals, and we see gold eventually reaching a fresh record. However, the timing for a fresh push to the upside will remain very dependent on US economic data 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.
While gold remains stuck within a narrowing range, currently between $1900 and $1950, silver was the surprise winner this past week, rising by close to 3%, despite the headwinds from lower industrial metal prices. The chart below shows strong support with the combination of three major lows since last September being joined recently by three daily lows in the $22.30 area. Adding to this the relative strength against gold with the XAUXAG ratio trading down to 81.3 after having created a double top at 85.30 earlier this month.
An emerging and long overdue correction in crude oil stopped short of reaching its full potential this week after Russia announced a temporary export ban on diesel and gasoline, a move that was driven by consistent high domestic demand for diesel from military forces and farming as the harvest season picks up speed. The ICE gasoil futures contract jumped on the news, dragging crude oil higher with it before losing steam in the realisation that the ban would only last for a few weeks. Russia does not have the capacity to store excess fuel production, and a prolonged ban could force refineries to cut runs thereby reducing demand for crude, which could force a very unlikely cut in crude production.
Meanwhile, Saudi Arabia and Russia’s decision to extend current voluntary production and export cuts until yearend continues to support the market, at least in the short term. The prospect for a large deficit ahead of yearend will offset economic growth worries, especially if the Fed fails to achieve a soft landing, thereby forcing the market focus back to demand and, with that, potential long liquidation from hedge funds that during a two-week period to September 12 increased their combined net long in Brent and WTI by 35% to 527 million barrels, the biggest exposure and strongest belief in higher prices since March 2022.
Most extended right now is the speculative long in WTI crude oil futures, driven by a sixth consecutive weekly drop at Cushing, the world’s largest storage hub and delivery location for WTI futures contracts. Since June, Cushing has seen a 47% decline to 22.9 million barrels, the lowest seasonal level since 2018. One way to measure whether a position is becoming too one-sided is by looking at the long-to-short ratio: during the past month, this has surged from 3.5 long per one short to 14.6, a fifteen-month high. A discrepancy this extreme is no problem while the market rallies but once a reversal sets in, sellers of long position may find it difficult to find bids in the market.
We continue to monitor refinery margins for gasoline and especially diesel as they provide insights into the strength of demand, and when refinery maintenance potentially cuts demand for crude oil.
It was the rejection at $93.75 in WTI, a double-top from October and November last year, which triggered a long overdue correction, and while the Russian export ban on fuels helped arrest the slide, the downside risk at this stage seems limited to the 38.2% retracement of the recent rally (see chart) at $87.60 with the similar level in Brent being $90.60.
Copper traded on the London Metal Exchange slumped to a May low at $8070 before finding buyers, as the fallout from the hawkish Fed decision reverberated across markets depending on growth and demand. Meanwhile, HG copper traded in New York managed to find support ahead of the August low at $3.627 before bouncing. In recent weeks, the attention has been on the Chinese economy and the government's efforts to support its property sector and currency. However, the hawkish message sent by the Fed this week triggered the selling of a metal that was already dealing with a recent 50% jump in exchange-monitored stocks and a deepening contango, both pointing to a current oversupply. Overall, copper has despite of this been stuck in relatively narrow ranges for the past three months, and while the short-term outlook remains somewhat challenged, it does not alter our supportive long-term view on copper and other ‘green’ metals.
Wheat prices in Paris and Chicago remain under pressure from harvest pressure, along with competitive pressure from Russia where a second consecutive bumper harvest will likely continue to weigh on prices. As the northern hemisphere harvest season comes to an end and the final result is known, attention will turn to the southern hemisphere, not least Australia where climate models continue to indicate warmer and drier conditions for much of the country over the next three months. The Australia Bureau of Meteorology recently declared an El Niño weather event which may result in a 36% decline from the record harvest last year. The CBOT wheat contract trades near an area of support around $5.65 per bushel, with a weaker dollar potentially needed to support prices.
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