Head of Commodity Strategy
Summary: The first week of December saw weakness spread to all the major commodities sectors with grain being the most notable exception. Price weakness being driven by the growth and demand-dependent energy and industrial metal sectors in response to continued worries about the near-term direction of the global economy, not least in China where data continues to point to softness, and the US, where the prospect of a soft landing continues to gain traction
The first week of December saw weakness spread to all the major commodities sectors with grain being the most notable exception. Overall the Bloomberg Commodity Index, which tracks 24 major commodity futures across the energy, metals and agriculture sectors, was heading for a 3% weekly loss, driven by the growth and demand-dependent energy and industrial metal sectors in response to continued worries about the near-term direction of the global economy, not least in China where data continues to point to softness, and the US, where the prospect of a soft landing continues to gain traction.
These growth worries have seen the index head for an annual loss of around 8% with the biggest contributor being US natural gas which has suffered a 64% slump in 2023 amid rising production and lower weather-related demand. The agricultural sector traded mixed with the recent high flying softs sector seeing some profit taking led by a 7.5% sugar slump, while the grains sector was heading for a second back-to-back weekly gain led by a strong rally in wheat.
Precious metals suffered a setback following gold’s dramatic and unsuccessful attempt to break higher in the process - wrong footing both buyers and sellers. Crude oil meanwhile witnessed the longest run of weekly losses since 2018, driven by signs of softer demand in China and growing doubts that the additional production cuts announced at the start of the month will be delivered amid producers struggling with rising budget deficits as the plan to support higher prices in recent months has backfired, as it hurt demand while leaving the door wide open for rising non-OPEC production.
On December 13, the FOMC will meet for the last time this year, and while no change in rates are expected, the meeting may still trigger a great deal of volatility before markets finally settles down ahead of the quiet Christmas and New year period. Markets are pricing in 125 basis points rate cuts by the end of next year as investors are fast to claim that inflation is dead. However, the FOMC September dot plot shows that policymakers expect to cut rates only twice next year, making the divergence between markets and the Federal Reserve's projections the perfect volatility cocktail.
Wheat futures in Chicago were heading for their biggest weekly advance since June with the futures contract on track to record the longest run of gains since 1993. The near 7% rally from a three-year low was triggered by an unusual rush of Chinese demand for US wheat after severe rains damaged the harvest earlier this year. The purchase of 1 million tons announced by the US Department of Agriculture this past week was the biggest order in a decade and with the buying program likely to continue, it will help offset some of the negative price focus following a generally strong production year across the Northern Hemisphere. This has put pressure on prices while raising the net short held by speculators in the futures market. In addition, Russian attacks on a Ukraine export facility on the Danube River raised concerns about Ukraine’s reliance on the Danube as the main grain export route after Russia pulled out of the UN-backed agreement in July that allowed shipments via Black Sea ports.
Having rallied from a $5.275 low, the front month contract, currently for March 2024 delivery, has broken above the 200-day moving average and the downtrend from the 2022 record peak. It will however likely find some resistance above $6.50 given the prospect for an upgrade to production in Australia and a record Russian production weighing on the market.
Copper reached a five-month high at $3.933/lb in early December, driven by supply concerns following the closure of a major mine in Panama, before suffering a 5% correction to $3.73/lb amid profit taking in response to a stronger dollar, weak Chinese manufacturing data and Moody’s cutting the outlook for China’s government credit ratings to negative from stable driven by concerns about China’s fiscal, economic and institutional strength.
The weakness however proved short lived as the physical market continues to send a signal of robust demand after China’s November imports of unwrought copper and copper products, used widely in construction, transportation and power sectors climbed 10% from the prior month to the highest in almost two years. Together with strong demand from green transformation industries leading to dwindling stocks and more recently, a stronger Yuan, have all helped underpin prices, despite concerns about the wider global economic outlook into 2024.
Our structural long-term bullish view on copper has only been strengthened by these latest supply and demand developments, and the global copper market is likely to see a deficit emerge already next year, potentially forcing prices higher sooner than expected.
Having closed the previous week at a record high at $2040, the yellow metal continued higher on Monday with short covering and fear of missing out (FOMO) buying seeing the price briefly trade above $2135 before suffering a 125 dollar slump, partly driven by the realization that fundamentals are not yet aligned strongly enough to support a continuation at this stage.
Despite the latest setback, which did not significantly damage the prospect for higher prices, gold trades up more than 11% this year, and on track for its best year – priced in dollars – since 2020 when it jumped by a quarter. Driven by a sharp drop in US Treasury yields amid signs of a softening economic outlook and falling inflation raising the prospect for the aggressive rate hiking regime that we have seen over past couple of years, being replaced by an equally aggressive cutting cycle next year, currently to the tune of five 25 basis points cuts.
We maintain a bullish outlook for gold into 2024 in the firm belief that rates have peaked, and that Fed funds and real yields will start to trend lower. However, with a great deal of easing already priced into the market, both silver and gold will continue to see periods where convictions could be challenged. It is also worth noting the continued lack of demand from ETF investors, not least asset managers who remain on the sidelines, and actually sold into the latest rally, amid the wide gap between gold and US real yields as well as the current high cost of carry which will only come down when the Federal Reserve starts cutting rates.
Instead, the recent rally has been mostly driven by hedge funds and other momentum driven traders, and it is worth keeping in mind that speculators are not 'married' to their positions and will adjust if the technical and/or fundamental outlook changes. For the “Santa” rally staying on track, gold needs to hold above $2000, and if successful we see the potential for this area becoming the new floor from where gold may make fresh upside attempts in 2024.
Crude oil prices are showing signs of stabilizing following a six-day slump that took prices of WTI and Brent down to six month lows, and near levels that previously helped trigger intervention by OPEC+ through production cuts. The latest weakness has been driven by slowing demand, not least in China which saw its oil November oil import fall by 1.2 mb/d, and together with weaker refinery margins and slower refinery run rates, this paints a picture of softening demand from the worlds biggest importer of crude.
In addition, some of the weakness has been driven by speculation that OPEC+ is running out of options to stem a fresh slide, especially after the November 30 meeting which highlighted an emerging discord within the group. Instead of strong action to stem the lower demand driven price weakness, the group instead opted for additional voluntary cuts which if carried out, would amount to around 2.2 million barrels a day in the first quarter of next year. Cutting production while prices are falling is a very painful process for producers who need to maximize production in the coming years before the energy transition away from fossil fuels eventually sees demand begin to weaken.
Some stability has emerged in the market ahead of the monthly US job report after Russia and Saudi Arabia both gave verbal support to the market, both emphasizing the ongoing efforts to stabilize global oil markets through active supply management. The risk of an emergency OPEC+ meeting being called should prices drop further has also helped support the market.
Given the current outlook for continued demand growth in 2024, albeit at a lower rate than 2023, the risk of much lower prices seems unlikely, we expect Brent crude will spend the coming period trading mostly in the low $80’s with the biggest downside risk being lack of compliance and worries about OPEC+ unity. The upside potential is equally limited by the risk of an economic slowdown taking hold in the USA and China, as well as continued focus on rising production spare capacity, especially among producers in the Middle East, led by Saudi Arabia and the UAE.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
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