Crude oil markets look set to tighten further in 2022, with several producers within the OPEC+ group already struggling to meet their allocated quotas. With that in mind and considering US production struggling to reach pre-pandemic levels, we maintain a long-term bullish view on the oil market. It will be facing years of likely underinvestment 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.
Global oil demand is not expected to peak anytime soon and that will add further pressure on spare capacity, which is already being reduced on a monthly basis, courtesy of OPEC+ production increases. According to OPEC and the IEA, the early months of 2022 could see an oversupplied market, but with spare capacity starting to run low and demand reaching a pre-pandemic peak, we see Brent crude oil reach into the $90s, and potentially above $100 during the second half.
Industrial metals rose strongly in 2021, but with most of the 32 percent jump in the London Metal Exchange Index occurring during the first half, the year ended with some degree of uncertainty. After hitting a record high in May, copper spent the remainder of the year trading sideways on continued worries about the outlook for the Chinese economy, especially its troubled property sector. Aluminium, one of the most energy-intensive metals to produce, also rose strongly in 2021, and the outlook remains supportive with supply disruptions at the end of 2021. This adds further fuel to expectations of a growing supply deficit this year, not least considering the outlook for slowing capacity growth in China as the government steps up its efforts to combat pollution, and ex-China producers for the same reasons being very reluctant to invest in new capacity.
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 sizeable portion of Chinese demand relates to the property sector. But 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.
This is supported by the prospect of the PBOC and the government—as opposed to the US Federal Reserve—stimulating the economy, especially with the focus on green transformation initiatives that will require industrial metals. With inventories of both copper and aluminium already running low, development could, in our opinion, be the trigger that sends prices back towards—and potentially above—the record levels seen last year. Months of sideways price action has cut the speculative length, thereby raising the prospect for renewed buying once the technical outlook improves; in HG copper that signal would likely be triggered on a break above $4.50 per pound.
Precious metals was the only sector suffering declines last year, but considering the headwinds from rising bond yields and a stronger dollar, gold’s negative performance of around 3.6 percent was acceptable from a diversified portfolio perspective. Being the most dollar- and interest rate-sensitive of all commodities, gold will take some—but not all—of its directional inspiration from these two markets. Gold is often used by fund manages as a protection against unexpected events, whether they are macroeconomic or geopolitical developments. The wall of money provided by governments and central banks following the first wave of the Covid-19 outbreak helped reduce macroeconomic risks, while sending the stock market sharply higher.
Just like in 2021, gold has started the year on the defensive and once again the early weakness was driven by surging bond yields, after the US Federal Reserved signalled it would step up its efforts to combat inflation. During the first week of trading US ten-year real yields surged higher by 0.3 percent, but instead of responding with a sharp selloff as seen during similar periods last year, gold managed to hang on to $1800/oz, a level around which the market traded for a considerable amount of time during the latter part of 2021.
Into the early part of 2022 gold looks stuck within a wide $1740 to $1860 range. Key to the short-term direction is how it balances the opposite pulls from the potential risk of yields surging higher against raised market uncertainty, and the dollar which may struggle to replicate last year’s strong performance. However, with the market already pricing in close to four rate hikes in 2022 with the first one pencilled in for March, and inflation already running above 7 percent, we question how much worse, from a gold pricing perspective, data and expectations can get in the short term.
With this in mind and considering continued robust EM and central bank we maintain a bullish outlook for gold—and potentially even more so for silver—once industrial metals, as expected, resume their rally. The expected rally to a fresh high may however be centred around the second half, especially if, as John Hardy says in his FX Outlook, the Federal Reserve continues to hike rates until things break.