WCU: Commodities look to China Congress for direction
Head of Commodity Strategy
Summary: The commodity sector, led by crude oil and fuel products, continued to show strength despite ongoing concerns that central banks’ battles against inflation through aggressively hiking rates will tip the global economy into a deeper slowdown than already seen. While the market continues to focus on dollar and bond yield developments in order to gauge the wider economic outlook, the attention now turns to China and its twice-a-decade National Congress for initiatives that may support demand from the world's biggest consumer of raw materials
The commodity sector, led by crude oil and fuel products, continued to show strength despite ongoing concerns that central banks’ battles against inflation through aggressively hiking rates will tip the global economy into a deeper slowdown than already seen. Not least in Europe, where the “hybrid war” with Russia has driven gas and power prices sharply higher. This is while there are raised concerns ahead of the February 2023 implementation of an embargo on fuel supplies from Russia.
Overall, the fourth quarter has started on a firm footing, with the Bloomberg Commodity index rising by more than 3% with support primarily from the OPEC-forced rally in crude oil and fuel products, not least distillates where low stocks have driving up refinery margins to a record in New York.
While US inflation is expected to start slowing soon, thereby providing some relief to global economies hurt by a strong dollar, the market will have to wait at least another month – after the September print came in higher than expected. With US consumers remain in good shape and are still spending, the global economy will continue to be challenged by the US FOMC hiking into strength while others are being forced to hike into weakness – supporting the strength of the dollar. This will be the case until we reach peak hawkishness from where US yields – we focus on two-year notes, currently at a 15-year high – and the dollar begin to recede.
Russia’s war in Ukraine and the actions taken by the West to counter Putin’s behaviour remain a key source of support for several commodities, including wheat, aluminium and diesel, thereby offsetting the potential risk of a slowdown in demand. In addition, the contentious decision by OPEC+ – led by Saudi Arabia and Russia – to cut production, despite the risks of such action further damaging the global growth outlook, has supported a strong recovery in crude oil.
Meanwhile, the industrial metal sector remains stuck near an 18-month low as Chinese lockdowns have hurt demand. However, during the past couple of weeks, the market has become more balanced. Lower visible stock levels in China indicated a pick-up in demand, while the risk of sanctions against Russia’s industrial metal industry could see supply for aluminium and other metals drop.
Focus on China and its twice-a-decade National Congress
The Chinese Communist Party meets on October 16 at its twice-a-decade National Congress. The decisions being taken will be watched closely by commodity traders considering the importance of China as the world’s biggest consumer of raw materials. Apart from the general risk to global growth, another source of price weakness remains China. This is where the government’s firm belief in its zero-Covid policy has reduced growth and consumption, while an ongoing property crisis has also clouded the economic outlook.
The focus will be on General Secretary Xi Jinping’s speech on October 16 when he presents the Work Report of the 19th Central Committee. The market is looking to the leadership and the report for a route that will steer the nation out of its current economic slump. However, any hopes that China might loosen its zero-Covid measures received a setback this past week when the People’s Daily newspaper defended the strategy three days in a row. Nevertheless, the market will be looking for additional economic support and stimulus, primarily towards infrastructure and energy transition projects, all of which are supportive for the industrial metal sector.
Commodity sector still signalling tightness despite a major correction
Multiple uncertainties, as seen through the continued level of volatility and falling liquidity, will continue to impact most commodities ahead of the year end. While the recession drums will continue to bang ever louder, the sector is unlikely to suffer a major setback before picking up speed again during 2023. Our forecast for stable or potentially even higher prices led by pockets of strength in key commodities across all three sectors of energy, metals and agriculture will be driven by sanctions, upstream cost inflation, adverse weather, low investment appetite and continued tightness across many key commodities from diesel and gasoline to grains and industrial metals.
Crude oil market navigating politics and demand concerns
Crude oil traded softer on the week in response to renewed demand concerns, but still higher on the month after OPEC+’s decision to cut their baseline production by 2 million barrels per day from November. The decision was heavily criticised by consuming nations for being premature and ill-timed and it triggered an unusually strong rebuke from the International Energy Agency who, in their monthly oil market report, said the cut would increase energy security risks worldwide, thereby leading to higher prices and volatility, and potentially ending up being the tipping point for a global economy already on the brink of recession.
With Saudi Arabia being one of a handful of producers having to cut production, the move, just ahead of an embargo against Russian exports, has been seen to benefit Russia at the expense of the global consumers, including China – the world’s biggest importer. Some support for the decision, however, was provided by OPEC, EIA and IEA after they all made downgrades to their 2023 demand outlook. However, with no one yet talking about a contraction in demand next year, the continued risk to supply from Russia and other producers struggling amid lack of investments and high costs, the risk of higher prices into an economic slowdown remains.
A wave of nuclear demand is coming.
The Canadian uranium miner Cameco and Brookfield Renewable Partners announced this week that they are jointly acquiring Westinghouse Electric, which is a player in the nuclear power industry, in a deal worth $7.9bn. Westinghouse Electric makes technology that is used in around half of all the 440 nuclear reactors in the world and, given that the company only came out of bankruptcy four years ago, tells everyone how much has changed for the industry.
Cameco’s CEO said in an interview that they are seeing some of the best market fundamentals ever for the nuclear energy sector. He went on to say that they are seeing a ‘wave’ of demand coming from Europe, specifically Eastern Europe, as Russia’s invasion of Ukraine has been a game changer. According to the World Nuclear Association, there are 55 reactors under construction (90 if planned reactors are taking into consideration) with most of these reactors being built in Asia, supplementing the existing 440 nuclear power plants. This year nuclear power plants will produce 10% of the world’s electricity. All developments that, if accelerated, could end up moving peak oil demand closer.
Gold and silver are still waiting for the ducks to line up
Having been under pressure for months in response to hawkish central bank actions to curb inflation through aggressive rate hikes, gold and silver both caught a bid recently on expectations that the US Federal Reserve was getting close to peak hawkishness. While the short squeeze turned out to be premature, it highlights the upside potential to prices when the tides turn. I.e., when the market senses that US yields have reached a peak from where they can drift lower.
However, the timing of the change was delayed further this past week when a stronger than expected US job report was followed by another strong inflation print, both highlighting the need and risk of additional aggressive rate hikes from the US Federal Reserve. All these developments highlight the continued need to focus on inflation and economic data for signs of any weakness to support a shift in the hawkish stance being signalled by the Federal Reserve. Ahead of the latest inflation print, Federal Reserve Vice Chair Lael Brainard had laid out the case for exercising caution, noting that the previous increases are still working through the economy at a time of high global and financial uncertainty.
Looking ahead, we see no reason to change our long-term bullish view on gold, with support potentially coming from the risk of a policy mistake sending US economic growth, the dollar and bond yields lower. In addition, we fear that the long-term inflation level may end up at a higher level than is currently being priced in by the market. Failure to bring long-term inflation down towards market expectations may trigger a major, and gold supportive, realignment between (rising) breakeven yields and (falling) real yields.
Rising gas inventories and falling gas prices in the US and Europe
US natural gas prices continues to slump and after hitting a 14-year high at $10 per MMBtu in August. It has now seen the longest weekly losing streak since 2001 on a combination of rising production and steady demand supporting a rapid build in US inventories ahead of the peak winter demand season. In recent weeks, production has constantly held above 100 billion cubic feet per day, a year-on-year increase at around 7.5% and with demand and exports through LNG holding steady, the rapid stockpile build has seen the deficit to the five-year average narrow to just 6.4% from 18% back in April.
In Europe, the energy crisis continues. However, the risk of supply shortages can increasingly be ruled out this coming winter following a rapid build-up in gas inventories across the region during the past three months. The need to reduce the dependency of Russian supplies have supported strong demand for LNG, not least supported by lower competition for cargoes from Asia due to the economic slowdown in China.
With Russian supply down by 80% compared with this time last year, Russia’s ability to rattle the market has been much reduced. Supported by consumers and industry cutting demand, a mild weather beginning to the heating season and not least strong imports from Norway and through LNG have driven a rapid build-up in storage to 91% of full capacity. The result being a +20% slump in Dutch TTF benchmark gas so far this month below €150/MWh. However, to support continued rationing, the likelihood of a further major slump towards €100 is unlikely to occur until we get deeper into the winter when the demand outlook becomes clearer.
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