Head of Commodity Strategy
Summary: The COT reports published weekly by the US CFTC highlight futures positions and changes made by hedge funds across commodities, forex and financials during the latest reporting week to last Tuesday, December 7. A week that saw stocks trading higher on optimism the omicron variant wouldn't derail global growth. Treasury yields and the dollar rose while the commodity sector received a fresh bid following its worst slump in more than a year. With yearend and the low liquidity season upon us, speculators went against the direction of the markets and instead opted to reduce exposure in both commodities and the dollar.
This summary highlights futures positions and changes made by hedge funds across commodities, forex and financials up until last Tuesday, December 7. A week that saw the biggest one-day rally in US stocks since March on optimism the omicron variant wouldn’t derail global growth. Treasury yields and the dollar rose while the commodity sector received a fresh bid following its worst slump in more than a year.
However, looking across all the asset classes covered in this update, we find position squaring becoming a major theme. December is normally a time of year when traders reduce exposure as liquidity starts to dry up as trading books are being reduced ahead of the holidays and yearend. With this in mind the net changes may not give much insights with regards to the short-term direction of the market. Examples being the reductions in dollar longs and commodities, both occurring in a week where both rose.
Commodities
Net selling of commodities continued for a second week, but at 117k lots the reduction slowed compared with the previous week where the 364k lots reduction was the biggest one-week reduction since the first round of Covid-19 panic hit the market in February last year. Despite strong gains with 20 out of 24 futures contracts trading higher, the general theme as mentioned was one of risk reduction with gross longs seeing a 124k lots reduction while the gross short was reduced by 8k lots.
Only a handful of contracts saw net buying led by corn (17.2k lots), soybeans (4.5k) and WTI (2.4k) while selling was led by natural gas (-37k), sugar (-22.8k), Brent (-13k) and gold (-11.6k).
Energy: The most interesting of the changes last week was the 13.1k lots reduction in the Brent crude oil long to a fresh 13-month low at 154k lots. The contract has now seen nonstop selling for the past nine weeks, and despite rallying by 9% last week, the recovery from the omicron washout and break above the 200-day moving average was not enough to persuade speculators to change their defensive stance. A behavior which is in stark contrast to the overall market belief in higher prices into 2022.
Commodity related updates from our daily Market Quick Take available here
Crude oil (OILUKFEB22 & OILUSJAN22) trades near a three-week high as the market continues to view current omicron worries as short term concerns and mounting speculation that China, the world’s biggest buyer of crude oil, will start adding fiscal stimulus in early 2022 in order to stabilise the economy. Both Brent and WTI are challenging their 21-day moving averages with a break above potentially adding more technical momentum. Speculators meanwhile reduced Brent crude oil longs in the week to December 9 for a ninth, and nine weeks of non-stop reductions have seen the net long drop to a 13-month low. A behavior which is in stark contrast to the overall market belief in higher prices into 2022. Focus turning to monthly oil market reports from OPEC today and IEA tomorrow.
Gold (XAUUSD) remains stuck below its 200-day moving average at $1794 with focus this week on Wednesday’s FOMC meeting, and how they will respond to inflation rising at the fastest pace since the 1980’s. The market is currently pricing in three rate hikes next year with the first one due around June. Countering the negative price impact of a potential more aggressive US central bank, the rapid spreading of the omicron virus is also receiving some attention given its potential negative growth impact.
Industrial metals have started the week on a firmer footing with iron ore jumping 6% on raised expectations that China will move to increase stimulus next year to support the economy. Following the end of a three-day annual Central Economic Work Conference, the party signaled a clear change in focus away from growth towards ensuring stability. They also vowed to front load policies to halt the recent slide.
Surging EU gas prices ahead of the European Council meeting on December 16. Apart from having to deal with Covid-19 and the Russian threat on its eastern borders, the council is also set to decide whether investments in gas and nuclear energy should be labelled climate friendly. The design of the EU green investment classification system is closely watched by investors worldwide and could potentially attract billions of euros in private finance to help the green transition, especially given the need to reduce the usage of coal, the biggest polluter.
Forex
In forex, the speculative flow was skewed towards dollar sales, primarily driven by short covering in EUR, JPY and CAD. Just one week after hitting an 18-month high on omicron worries and heightened Fed tightening focus, the overall dollar long against ten IMM currency futures and the Dollar index was reduced by 16% to $23.3 billion.
As can be seen in the table below, the overall focus was primarily on reducing exposure which helps to explain that the dollar length was reduced in a week where the greenback rose. The 4.6 billion dollar reduction was primarily driven by a 5.1 billion dollar equivalent broad reduction in gross short positions led by JPY ($1.9 bn) and EUR. Other major changes was the MXN net short which reached a four-year high at 64k lots or the equivalent of $1.5 billion.
The COT reports are issued by the U.S. Commodity Futures Trading Commission (CFTC) and the ICE Exchange Europe for Brent crude oil and gas oil. They are released every Friday after the U.S. close with data from the week ending the previous Tuesday. They break down the open interest in futures markets into different groups of users depending on the asset class.
Commodities: Producer/Merchant/Processor/User, Swap dealers, Managed Money and other
Financials: Dealer/Intermediary; Asset Manager/Institutional; Leveraged Funds and other
Forex: A broad breakdown between commercial and non-commercial (speculators)
The reasons why we focus primarily on the behavior of the highlighted groups are:
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
