Head of Commodity Strategy
Summary: The commodity sector traded lower for the first time in three weeks, thereby reversing some of the recent strong gains. The correction being led by growth dependent commodities in energy and industrial metals after several central banks hiked rates and after a combatant Jerome Powell, the Fed chair, told the US Congress that more rate hikes were needed. In addition, the commodity sector was also left underwhelmed and unimpressed by China’s latest initiative to support and stimulate growth. Except continued strength in grains the bottom of the performance table was represented by a broad selection of commodities from different sectors.
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The commodity sector traded lower for the first time in three weeks, thereby reversing some of the recent strong and broad gains that, at one point, sent the sector towards its strongest monthly performance in 15 months. While suffering a 3% decline this week, the Bloomberg Commodity Index is still heading for its first monthly gain since November. The weakness this past week has primarily been led by growth dependent commodities in energy and industrials after a combatant Jerome Powell, the Fed chair, told the US Congress that more rate hikes were needed in order to curb inflation which, in some areas, is showing signs of becoming more sticky.
The prospect of even higher rates helped send a shiver through equity markets while bond yields rose and broad dollar strength helped reverse some the recent declines. All these developments are being driven by concerns that economic growth, and with that demand for commodities, may suffer as central banks continue to apply the brakes through higher rates. Ultimately this path, if continued, will raise some important questions about the effectiveness of combatting inflation relative to the potential economic damage it may cause. At Saxo we maintain our long-held view that inflation is becoming sticky and unlikely to return to levels currently being targeted by central banks. If that sentiment spreads, we may see increased volatility as markets adjust, and in the process add fresh support to commodities from an inflation hedge perspective.
In addition to central bank actions on rates, the commodity sector was also left underwhelmed and unimpressed by China’s latest initiative to support and stimulate growth which has stalled amid a global economic slowdown and a less commodity intensive post-pandemic recovery driven by the service sector. Over in Europe meanwhile a slump in factory output gauges offered further evidence of stress across its industrial economy, not least in Germany where a sharp decline in activity helped drive a bigger-than-expected drop in Eurozone Manufacturing PMI for June.
The recent surge across the grains sector showed signs of cooling, but with drought conditions showing no signs of easing across key growing regions, the prospect for a major reversal in prices seems limited at this stage. Much, however, still depends on whether current weather developments persist in the coming weeks, not only in the US, but also across drought-stricken areas in Northern Europe as well as pockets in the Black Sea region. In the US the current drought conditions have not yet caused any irreversible damage to corn and soybean yields but the clock is ticking, and rain will be needed soon.
After months of price weakness, the grain and soybean sectors are trading up around 16% this month, according to the Bloomberg Grains Index. These gains are being led by CBOT wheat (23%) with soybeans and corn both trading higher by around 16%. The market is closely watching weekly crop condition data released on Mondays, after the latest update showed the percentage of corn fields being rated as good to excellent falling to 55%, down from 61% the previous week and lowest reading for this time of year since 1992. Soybean ratings came in at 54% good to excellent versus 59%, while the portion of spring wheat in this category dropped to 51% from 60% the previous week.
Apart from the need to consolidate as prices reached overbought territory and the stronger dollar making US grain export more expensive for overseas buyers, the end of week profit taking can also be partly explained by reduced buying pressure from speculators. Following months of weakness this group of traders had been trading the grains sector from a short perspective and it left them woefully unprepared for the sudden spike in prices, which forced them initially to cover short and most recently to become net buyers. Based on positioning only, the wheat market may potentially see further upside after hedge funds, for many months, held a large short positions which they are unlikely to have fully exited yet.
In this recent update from our equity strategist, Peter Garnry, he writes that agribusiness stocks are among the best performing segments of the equity market in June, up 8.1% compared to just 5.1% for global equities. The combination of stable to higher crop prices and the focus on initiatives to support production despite increased weather volatility is likely to drive more price supportive mergers and acquisitions across the sector in the coming years.
Copper prices traded softer following a three-week sprint that saw prices in London and New York recover strongly from a six-month low. Apart from growth worries caused by rising interest rates and the soft EU manufacturing PMI, the various measures of stimulus announced by the Chinese government and the People’s Bank of China, has so far left the market unimpressed by its potential. In our opinion, not least considering these latest developments, copper prices have held up very well, and the reason being a continued drop in stocks monitored by the three major futures exchanges in London, New York and Shanghai, most recently to a fresh six-month low at 246,000 tons, less than 50,000 tons above the multi-year low seen last December.
Additional Chinese stimulus or not, we continue to see a clear path towards higher prices in the coming years as the importance of the green transformation theme and its impact on several so-called green metals will continue to provide a strong tailwind, especially for copper, the best electrical-conducting metal for the green transformation - including batteries, electrical traction motors, renewable power generation, energy storage and grid upgrades. Producers will face challenges in the years ahead with lower ore grades, rising production costs and a pre-pandemic lack of investment appetite as the ESG focus reduced the available investment pool provided by banks and funds.
In the short term we are watching copper’s behaviour around the 200-day moving average, in High Grade at $3.82/lb and LME at $8410/tons with the risk of a deeper downside correction the biggest risk.
Gold traded below previous support around $1930 while silver, given its industrial link, suffered an even bigger setback in response to the stronger dollar and higher US Treasury yields that followed Fed Chair Powell’s comments about the need for higher rates to combat not-yet-under-control inflation. In addition, the hawkish surprise from central banks in Norway and the UK raised some additional concerns about the short term outlook for non-interest paying investment such as metals.
A peak rate scenario has and will in our opinion continue to be the event that triggers the next upward extension in precious metal prices and given the latest signal from the US Federal Reserve that timing could now potentially suffer another delay before the inevitable peak is reached. How the market responds in the coming weeks will continue to be very data dependent as any signs of economic weakness will impact how the market prices the prospect for rate hikes, currently only one additional 25 basis point hike has been priced in before year end.
For several reasons highlighted in previous updates and despite the current setback, we maintain a long held positive outlook for gold and from a technical perspective, it needs to drop below $1800 for that to change. In the short term a close above the 21-day moving average, last at $1950, would be the minimum requirement for a reversal in the current defensive stance adopted by the market.
Crude oil continues to trade sideways near a cycle low within a seven-dollar wide range between $71.50 and $78.50, as traders continued to gauge the impact of Saudi Arabia’s decision to go it alone to support prices at the recent OPEC+ meeting. However, once again, the lower end of the aforementioned range is being challenged after central banks, through their continued hiking of rates, raised concerns about the economic outlook.
Earlier this month, the International Energy Agency (IEA) joined OPEC in delivering an upbeat assessment of the short term demand outlook. In their monthly ‘Oil Market Reports’ for June, both OPEC and the IEA raised their outlook for 2023 global demand. Both forecasters are looking for some emerging tightness in the coming months amid OPEC+ production cuts, but with almost half this year’s demand growth expected to occur during the coming quarter, some room for disappointment exists, potentially preventing prices from going higher in the short term.
With this in mind, the coming quarter could potentially make or break the crude oil market as, dependent on whether OPEC and IEA is correct or whether - as the Saudi unilateral production cut earlier this month tried to preempt, we could see economic activity slow to an extent prices suffer further declines. In such a situation it will be interesting to see how it is being handled by OPEC and not least, Saudi Arabia. Having already cut production, thereby giving up market share to support the price, the Kingdom is likely to apply intense pressure on other producers to make additional cuts.
At Saxo, however, we believe a US recession will be avoided and that China will step up its efforts to support the economy, but whether it will be enough to support higher prices through a tightening market remains to be seen. For now, we are left with a market where macro-focused funds once again prefer to trade the oil market from a short perspective as a hedge against further economic weakness.
In the short term, we are watching OPEC’s focus on supply management, which for now has kept the market supported above $70, while an upside break seems equally unlikely if the focus remains on a weakening economic outlook. From a technical standpoint, the $80 area in Brent will offer a great deal of resistance and funds positioned for additional weakness are unlikely to change their negative price view until we see the return of an 8-handle.
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