WCU: WCU: WCU:

WCU: Omicron and EU power volatility dominate focus into year-end

Ole Hansen

Head of Commodity Strategy

Summary:  Commodities traded mixed during a week which saw the US FOMC deliver an expected hawkish message as they stepped up efforts to combat surging inflation. However, a vicious post-FOMC reversal in risk sentiment unfolded, driving the dollar and bond yields lower, thereby supporting a recovery among some the commodities that had been under pressure ahead of the FOMC meeting. Crude oil traded mixed with the omicron variant clouding the short-term outlook while in Europe the energy crisis showed no signs of abating with strong demand not being met by an equally strong supply response.


Commodities traded mixed during a week which saw the US FOMC deliver an expected hawkish message as they stepped up efforts to combat surging inflation. However, after presenting the market with the prospect for three rate hikes in 2022 and 2023, a vicious reversal in risk sentiment unfolded, with the euro and other major currencies outperforming the US dollar, thereby supporting a recovery among some the commodities that had been under pressure ahead of the FOMC meeting.

US Treasuries, a key directional guide for investment metals, also delivered a surprise post-FOMC reaction. Just the day after making a hawkish shift complete with a fresh series of stronger economic, inflation and Fed policy forecasts, yields dropped along the entire curve. Apart from a relief rally driven by a deeper knowledge about the thinking within the central bank, the reaction was most likely also supported by the continued and rapid spreading of the Omicron virus, with the new variant driving a surge in cases around the world.

Despite the tailwind from a weaker dollar, the oil market traded softer with short-term demand concerns related to the Omicron virus supporting the International Energy Agency in its forecast for an oversupplied market into the early months of 2022. Natural gas prices continued to diverge with mild US winter weather driving prices down to levels normally seen during the summer months, while here in Europe a perfect storm of price-supportive events helped drive gas and power prices to fresh record highs.

The result of these developments was a relatively neutral week for the Bloomberg Commodity Index, which tracks a basket of major commodities spread evenly between energy, metals, and agriculture. Thereby consolidating its very strong 2021 performance, currently at 24%, the strongest annual jump since 2001.

Precious metals received a boost after the FOMC meeting delivered the expected hawkish tilt. Both metals had been under pressure since the surprisingly hawkish acceptance speeches from Fed chair Powell and vice chair Brainard on November 22. With most of the announced actions being priced in ahead of the meeting, both metals seized the opportunity to claw back some of their recent losses. With 10-year real yields returning to pre-FOMC levels below –1% and the dollar seeing its biggest retreat since October, gold managed to break above its 200-day moving average, a level that had been providing resistance in the run up to the meeting.

The outlook for 2022 remains clouded with most of the bearish gold forecasts being driven by expectations for sharply higher real yields. Real yields have throughout the past few years shown a high degree of inverse correlation with gold, and it’s the risk of a hawkish Fed driving yields higher that currently worries the market.

However, with three rate hikes already priced in for 2022 and 2023 and with gold trading at levels which look around 0.25% too cheap relative to 10-year real yields, the downside risk should be limited unless the Fed over the coming weeks and months turns up the rhetoric and signals a more aggressive pace of rate hikes.

Source: Saxo Group

It is also worth keeping in mind that rising interest rates will likely increase stock market risks with many non-profit high-growth stocks suffering a potential revaluation. In addition, concerns about persistent government and private debt levels, increased central bank buying and the dollar rolling over following months of strength, are all potential drivers that could offset the negative impact of rising bond yields.

Having broken above resistance-turned-support at $1795, gold will find support from short-term momentum buyers, but for the newfound strength to extend beyond that, longer-term focused investors need to emerge, and so far, total holdings in bullion-backed exchange-traded funds are not showing any signs of picking up. Perhaps due to the time of year when only strong investment cases are being reacted upon while others are being postponed to January.

Silver also deserves some attention after once again managing to find support, and since September buyers have emerged on four occasions below $22, thereby preventing a challenge at $21.15 key support from 2016. The chart action could potentially signal a major low is in the process of being established, but for now the metal needs support from both gold and industrial metals to force a major change in the direction.

Source: Saxo Group

Industrial metals, just like precious metals, received a post-FOMC boost but not before once again fending off another downside attempt with copper temporarily falling to a two-month low. Supporting the recovery was news that Chinese production of aluminum for November slowed due to persistent restrictions on energy consumption, thereby driving increased demand for stocks held at LME-monitored warehouses. Copper meanwhile found support after one of Peru’s biggest mines started winding down production amid community protests hampering output.

Annual outlooks and price forecasts from major banks with a commodity operation have started to roll in, and while the outlook for energy and agriculture is generally positive, and precious metals negative, due to expectations for a rise in US short-term rates and long-end yields, the outlook for industrial metals is mixed. While the energy transformation towards a less carbon intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizable portion of Chinese demand relates to the property sector.

Considering a weak pipeline of new mining supply, we believe the current macro headwinds from China’s property slowdown will begin to moderate through the early part of 2022, and with inventories of both copper and aluminum already running low, this development could be the trigger that sends prices back towards and potentially above the record levels seen earlier this year. Months of sideways price action has cut the speculative length close to neutral, thereby raising the prospect for renewed buying once the technical outlook improves.

Crude oil dipped on Friday to trade down on the week as Omicron developments continue to impact the short-term demand outlook. A weaker dollar has been offset by tighter monetary policies potentially softening the 2022 growth outlook further. While Europe is dealing with a worsening energy crisis, milder than normal weather in Asia has led to a less demand for fuel products used in power generation and heating. With the clouded outlook we expect most of the trading ahead of New Year to be driven by short-term technical trading strategies.

With the International Energy Agency, as well as OPEC forecasting a balance market during the early months of 2022, the risk of higher prices may have been delayed but not removed. We still maintain a long-term bullish view on the oil market as it will be facing years of likely under investment with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.

The EU gas and power market surged to a new record high on Thursday before paring back gains on Friday after Gazprom booked some pipeline capacity. Before then, the Dutch TTF gas future had closed above €140/MWh or $45/MMBtu, more than nine times the long/term average, while German Power traded more than six times higher than the long-term averaged at €245/MWh.

A combination French nuclear power plants temporary shutting down due to faults on pipes, an expected cold snap next week and low flows from Russia continue to reduce already-low inventories. Adding to this is US pressure to apply sanctions on Russia over Ukraine and German regulators saying the Nord Stream 2 gas pipeline may not be approved before July.

The market is clearly driven by fears about a February shortage of gas and with this in mind the market will continue to focus intensely on short-term weather developments as well as any signs of increased supplies from Russia. An improvement in both could see prices suffer a sharp correction as current levels are killing growth, raising inflation while creating pockets of fuel poverty across Europe.

Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.