Head of Commodity Strategy
Summary: The month-long commodity rally continues to be challenged by elevated bond market volatility driving a renewed rise in US bond yields and a stronger dollar. Pockets of strength seen in carbon emissions, platinum and gasoline while iron scraped the bottom as China stepped up its pollution focus. Gold sang to the tune of US real yields and crude oil showed signs of hitting a temporary top while waiting for a sustained demand pickup. Grain markets kept one eye on US and South American weather developments and a renewed outbreak of African swine fewer in China.
The month-long commodity rally continues to be challenged by elevated bond market volatility driving a renewed rise in US bond yields which in turn is causing risk aversity and a stronger dollar. These developments left the Bloomberg Commodity Index near unchanged and close to a 2-1/2-year high, and combined with a record long position held by funds, the sector is currently, despite strong underlying fundamentals, still at risk of entering a period of consolidation.
Metals of most colors saw their price action ebb and flow in line with dollar and bond yield developments. US stimulus supported copper despite signs of easing tightness, especially in the Chinese market where exchange-monitored stock levels have started their seasonal increase, albeit from a price supportive multi-year low. Platinum rose after report from the World Platinum Investment Council said 2020 produced the largest deficit on record, with third consecutive annual deficit expected in 2021.
Iron ore suffered a weekly loss after the Chinese Government initiated a pollution crackdown on steel mills in the steelmaking hub of Tangshan, one of most polluted cities in China. For steel, the government has already pledged to rein in capacity as the country embarks on its planned journey to carbon neutrality by 2060.
Staying with emissions, the cost of EU carbon allowances, the world’s biggest cap-and-trade program, rose by 7% to reach a record high at €42.6/tons. Apart from the relentless rise in crude oil, the latest part of the 31% year-to-date rally was driven by gas outages in Norway raising demand from power generators for more polluting alternatives which in turn requires more carbon allowances.
Grains & oilseeds: In China, a resurgence in African swine fever has sent local corn prices down to the lowest level this year and if not contained, the price weakness may spread to overseas markets, most noticeably to Chicago grain and oilseed futures. The combination of this, and less tightness being projected by the US Government in corn and soybeans, helped send the Bloomberg Grains Index lower on the week. While the losses, led by corn, were relatively small, a potential slowdown from China could leave the sector vulnerable to demand downgrades and with that the risk of selling from funds holding an elevated exposure in both corn and soybean futures. The weakness in wheat prices were primarily weather-related after beneficial rains fell on the US Plains.
With US grain prices having recently touched multi-year highs and the UN FAO Global Food Price index rising at the fastest pace since 2014, the market will soon turn its attention to the Northern Hemisphere planting and growing season. What allocation US farmers chose to use between corn, wheat and soybeans could become a major catalyst for price action over the coming months. With that in mind, grain traders will look towards the March 31 Prospective Planting Report from the US Department of Agriculture for guidance.
Gold (XAUUSD) and silver (XAGUSD) remained under pressure as the direction continued to be dictated by developments in the dollar and bond market where yields rose again in response to the passing of the $1.9 trillion stimulus package. While the deal will support growth, it will also stoke inflation risks but following a weak US CPI reading earlier in the week, such risk is not yet being reflected in the numbers.
We maintain a positive outlook given our belief inflation will eventually overshoot current market expectations. Until such time, however, a continued rise in 10-year bond yields towards the next big target at 2% from the current 1.6% could see the downside being challenged again. For now, gold remains caught in a downtrend with key support being an important area between $1670 and $1690 while potential buyers are in no rush to enter longs before it manages to regain $1765/oz, the level below which helped trigger the latest weakness.
Crude oil traded close to unchanged on the week as the market struggled for direction. Earlier in the week, a failed attack on a Saudi oil installation drove Brent crude above $70/b but the 7% correction that followed could reflect a market that potentially may have gotten close to its current potential. Despite being supported by the US stimulus Bill and signs of a fuel consumption rebound around the world, the market is still waiting to see a sustainable pickup in global fuel demand that can justify current oil prices.
The weekly EIA inventory report showed another large draw in gasoline stocks amid rising demand from motorists. Refinery disruptions during the Texas freeze a couple of weeks ago helped trigger a two-week jump in US crude oil stocks by 35.3 million barrels, while gasoline and distillate stocks have slumped by more than 40 million barrels. With the summer driving season and reduced lockdowns on the horizon, refineries will have a busy few months ahead and gasoline prices are likely to remain elevated during this time.
Somewhat offsetting the still positive sentiment was the renewed push for a higher yields and dollar together with OPEC striking a cautionary tone in its Monthly Oil Market Report. In their latest report for March they downgraded the outlook for demand for its crude over the next six months amid a weaker demand outlook and stronger non-OPEC supply growth. A development that calls for an extended period of production discipline and restraint from the OPEC+ group of producers. On March 17, the International Energy Agency will release its Oil Market Report.
Recently I was invited onto the MACROVoices podcast series to discuss various aspects of the current commodity market rally. I enjoyed my 50 minute discussion with host Erik Townsend, and I hope you will as well.
