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WCU: Energy sector doing the heavy lifting as metals falter

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector is showing a growing divergence between metals and energy, with the war in Ukraine continuing to raise supply concerns for crude oil, refined products and natural gas. Industrial metals trade lower on concerns about the short-term direction of the Chinese economy while precious metals are looking for a defense against surging yields and dollar as the US Federal Reserve steps up its battle against inflation.


The commodity sector is showing a growing divergence between metals and energy, with the Russia/Ukraine war continuing to raise supply concerns for crude oil, refined products and natural gas while industrial metals have suffered a continued setback on concerns about the short-term direction of the Chinese economy. During the past week, the Bloomberg Commodity Spot Index rose by 2.2% and sits just below the April record, but as the table below shows, the gains were mostly driven by strong gains in energy, led by US natural gas which surged to the highest level in almost 14 years.

Industrial metals have become increasingly challenged by China’s stubborn adherence to the Dynamic Zero Covid policy despite mounting economic and social costs. Lockdowns have reduced mobility, productivity and with that the economic growth outlook. On Thursday, the Standing Committee of the Chinese Communist Party, chaired by President Xi, doubled down on its policy and asked for its leaders not to waver in pandemic control. While infections in Shanghai, China’s financial hub, have been on a continuous downtrend since April 22, the prospect for a return to normality still seems weeks away.

China’s current situation was recently described by a major investor in Hong Kong as the worst in 30 years with Beijing’s increasingly fraught zero-Covid policies slowing growth while raising discontent among the population. As a result, global supply chains continue to be challenged with congestions at Chinese ports building, while demand for key commodities from crude oil to industrial metals have seen a clear drop. One of the consequences being the need for the government to launch a major stimulus drive to support a recovery in growth, currently well below the 5.5% target. Such initiatives are likely to support the industrial metal sector given the focus on infrastructure and energy transition, hence our view that following the recent weakness a floor is not far away.

Other current drivers for the commodity sector remains supply disruptions driven by the war in Ukraine supporting energy, while a continued surge in US bond yields and the dollar continues to create some headwinds for investment metals such as gold and silver. The US Federal Reserve stepped up its pace of tightening by raising its benchmark rate by 50 basis points with similar hikes expected at future FOMC meetings, the next on June 15 and July 27. The Bank of England meanwhile warned of recession risks from double-digit inflation, and the intensified concerns over inflation helped drive US ten-year yields past 3% while global stocks took another tumble, thereby souring the investment climate further.

At Saxo Bank, we focus our stock market attention on equity themes more than sectors and the above table shows the historic divergence seen this past year between former stock market darlings such as e-commerce, crypto & blockchain as well as bubble stocks personified through Cathie Wood’s ARK Innovation Fund. At the top of the table, we find our commodity basket which comprises 20 major companies involved within the three major sectors of energy, metals and agriculture, as well as defense given the increased focus on security following Russia’s invasion of Ukraine.

In a recent online seminar and in a podcast on MACROVoices I highlighted the reasons why we see the commodity rally has further ground to cover, and why they may rise even if demand should slow down due to lower growth.

Crude oil headed for its second weekly gain with the focus switching from the risk of slowing demand due to Chinese lockdowns and interest rate hikes, and back to supply which continues to tighten. OPEC+ announced another 432k barrels/day increase in oil production for June but with OPEC10 (those with quotas) trailing by 800k barrels/day in April and Russia and Kazakhstan being other laggards, the group is currently not able to deliver the barrels they have targeted. In addition, the EU ban on Russian oil imports and a surprise US announcement about starting to refill its SPR already this autumn also underpinning the price.

Continued focus on a slowdown in China helped prevent crude oil prices from surging higher after the European Union announced steps to remove its dependency on Russian crude and distillate products over the coming months. Stockpiles of middle-distillates in Singapore and New York, two major trading hubs declined further, amid a worsening global shortage, especially for diesel, the workhorse of the global economy. The drop in Singapore despite China’s lockdowns reflects a pickup in Asian consumption outside of China. 

We stick to our wide $90 to $120 range call for Brent during the current quarter while maintaining the view that structural issues, most importantly the continued level of underinvestment and OPEC’s struggle to increase production, will continue to support prices over the coming quarters. Next week, monthly oil market reports from the EIA on Tuesday and OPEC and IEA on Wednesday will be watched closely for clues about the current supply and demand situation.

U.S.-produced natural gas headed for its biggest weekly gain since 2020 and towards its highest weekly close since August 2008. Trading near $9/MMBtu, the price has now tripled compared with the 10-year seasonal average. According to Refinitiv, demand from U.S. LNG plants has since the start of March been averaging more than 12.3 billion cubic feet of gas (equivalent to 127 bcm), about 17% more than last year and almost as much as is consumed by the US residential sector.

In addition, the latest surge has been supported by expectations for hotter-than-usual weather over most of the South and Midwest while production continues to rise at only a modest pace. As a result, U.S. stockpiles are 16% below the five-year average, and the combination of strong demand for LNG cargoes from Europe and only a modest pickup in production is likely to see a slow inventory build over the coming months. In Europe, the Dutch TTF benchmark gas contract trades six times higher than its long-term average with continued concerns about Russian supplies keeping prices elevated.

Gold has settled into a wide $1850 to $1920 range with support from higher oil prices, given the signal it sends on inflation and geopolitical risks, being offset by continued dollar strength, now up 6.5% year-to-date, and a continued surge in bond yields across major economies. As we highlighted in a recent update, we continue to see gold’s performance this year as satisfactory. While the return in dollars remains low at just 2.6%, the continued dollar strength has ensured double digit returns for investors in other currencies, such as euro (10.7%) and yen (16%). Adding to this is the dismal performance of stocks and bonds, the relative performance highlights gold diversification credentials in a year as troubled as the current.

We maintain a positive outlook for gold driven by the need to diversify from volatile stocks and bonds as inflation becomes increasingly imbedded and the ongoing geopolitical concerns. As mentioned, the past week has seen a pickup in selling from technical-driven traders looking for rising yields to drive the price lower. In order for that focus to be changed gold needs a solid break back above $1920 per ounce. We are also keeping an eye on silver which has dropped back towards key support in the $21.50 to $22 area resulting in the XAUXAG ratio hitting a fresh eight-month high above 84 ounces of silver to one ounce of gold.

Source: Saxo Group
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