WCU: Energy surge drives renewed focus on inflation

WCU: Energy surge drives renewed focus on inflation

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector found a fresh bid this past week as the intense and potentially price-negative focus on China Evergrande Group, and its ability to service its debt, faded. While industrial metals recovered on the fading China focus, a fresh spike in bond yields together with a firmer dollar hurt investment metals already reeling from the lack of diversification demand from funds looking at financial assets and valuations near an all-time high. Once again a turbo-charged energy sector attracted most of the attention with crude oil, gas, coal and power all rising, and if not arrested the reflation focus may soon make a comeback.


The commodity sector found a fresh bid this past week as the intense and potentially price-negative focus on China Evergrande Group, and its ability to service its debt, faded. While the world’s most indebted property company could still spring a negative surprise, the continued pumping of cash into the financial system by The People’s Bank of China helped reduce contagion risks to other markets outside China.

The MSCI World index dropped 4% before recovering, thereby extending to 233 days the time gone by since we last saw a 5% correction across the global stock market. Probably a key reason why investment metals, such as gold and silver, are having such a troubled time this year. While often being closely correlated to movements in the dollar and yields, demand for gold is also inverse correlated to confidence in financial assets which currently, along with financial market valuations, remains near an all-time high.

Another development this past week that helped set the agenda for commodities, especially those with a high inverse correlation to Treasury yields and the dollar, was the sudden spike in US bond yields. On Thursday, the Bank of England set the ball rolling after hawkish rhetoric on the timing of the first rate hike wrongfooted investors. A selloff in gilts set the pace for euro-area rates before US Treasuries followed to produce the biggest one-day rise in 10-year yields in months.

Gas: One sector that remained immune to China worries and the risk of rising bond yields was the energy sector where crude oil, gas, coal and power prices continued to rally amid tight supplies and strong demand. Brent crude oil, the global benchmark, reached its highest settlement level since 2018, while in Europe the cost of benchmark Dutch TTF gas reached a record €76.5/MWh or $26/MMBtu, or $150 per barrel of oil equivalent, before a jump in EU wind generation helped put a brake on prices.

In the US, Henry Hub natural gas futures traded back above $5/MMBtu and after completing a 50% correction of the August to September surge to a 7 ½ year high, the technical outlook is once again pointing to further strength. Not least due to rising export demand for LNG and after a weekly government report showed inventories, just as in Europe, are still tight ahead of the winter peak demand period.

Source: Saxo Group

Crude Oil headed for its fifth weekly gain with multiple sources of support emerging. US hurricane Ida has removed +30 million barrels from the market and we continue to see a slow and prolonged return to pre-Hurricane levels. As a result, US crude oil and gasoline stocks have both declined to levels last seen in December 2019. Increased fuel consumption into the northern hemisphere winter due to the substitution of punitively expensive gas may further boost already recovering global demand. In addition, recent months have shown some OPEC+ members, most noticeably Nigeria, Angola and Kazakhstan have struggled to reach their production quota, thereby adding to the underlying market strength, though lower than expected supply. 

Countering the current rise, but so far with a limited price impact, was the first and historic sale of crude oil from China’s strategic reserves. In recent months, China has also been selling industrial metals from its reserves in order to combat surging input costs which have seen factory-gate inflation hitting a 13-year high. The first sale of 7.4 million barrels could be followed by more in the coming weeks with Wood Mackenzie estimating that as much as 82.5 million barrels may be offered. 

However, with this development having such a limited impact, it looks increasingly likely that Brent crude oil will reach $80 per barrel somewhat sooner than previously expected. From a technical perspective, the daily chart is showing some resistance at the July high at $77.84/b, while the monthly Brent chart is now showing a break above the downtrend from the 2008 record high, potentially a sign of more gains to follow.

Source: Saxo Group

Gold and silver continue to exhibit troubling behavior; stabilizing on falling yields, only to slump when they rise a bit. This week was no exception with gold struggling both before, and especially after, Wednesday’s FOMC meeting where Fed chair Jerome Powell delivered a surprisingly hawkish press conference, saying the Fed was ready to commence tapering from November while bringing forward the first rate hike to late 2022. The biggest drop came on Thursday when, as mentioned, the Bank of England managed to wrong-foot the market by signaling its first rate hike well ahead of the US, potentially already in February.

US ten-year yields broke higher through a key level of resistance at 1.4% while the corresponding real yield jumped 10 basis points to reach a three-month high at –0.89%. Gold is not only a metal which tends to respond to movements in the dollar and yields, both of which has been price negative for most of the year. It is also used by fund managers as a hedge or diversifier against risks across financial assets, but with financial assets and market valuations near all-time highs, this demand has faded and become a recent source of selling.

In other words, if you as an investor believes the current market confidence to be misplaced, the cost of buying insurance against it continues to get cheaper with gold presently trading near the lower end of its year-long range. Over the coming weeks we will watch yield developments closely with rising yields potentially raising renewed uncertainty across other asset classes, such as interest rate-sensitive growth stocks. Also, the continued surge in the cost of most energy sources will ultimately support our non-transitory views on inflation. For now, however, gold needs a solid break back above $1835, and until that happens, which we still believe it will, there are no major reasons to chase or add to any existing positions.  

Source: Saxo Group

Industrial metals recovered following the Evergrande-led slump which drove worries about Chinese demand, especially from the current under-pressure property sector. Iron ore, a key input to the production of steel currently at the epicenter of China’s crackdown on emissions in energy-intensive industries, traded at $110/tons on Friday following a dramatic slump which in just a few months has seen the price more than halve before bottoming out at $90/tons earlier in the week.

Copper, an important metal in the construction industry, also got caught up in the sell-off, but once again key supports around $4/lb in New York and $8600/tons in London did not get challenged before prices bounced back. We take this as another sign of underlying strength. And while Dr. Copper, one of the kings of the so-called “green” transformation, still lingers in a downtrend from the May peak, we still see the prospect for higher prices. While we wait for a greater high, initially above $4.63/lb, to attract fresh momentum buying, the risk of a deeper correction still exists, albeit somewhat reduced following the latest failed downside attempt. With this in mind, we maintain the view that copper remains a buy on fresh strength and any potential additional weakness.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research 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. To the extent that any content is construed as investment research, you must note and accept that the 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 under relevant laws.

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

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Support Centre
For existing clients, please click here to request support via the Support Centre.

Have a question about our products, platforms or services? Visit the Support Centre to find answers for our most frequently asked questions. If you are still unable to locate an answer to your question, you will also find contact details for your local Saxo office to speak with a representative.

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.