Head of Commodity Strategy, Saxo Bank Group
Summary: The first quarter of 2019 was the strongest in three years for the commodities sector as the global turnaround in central bank policy allowed growth-dependent energy and metals assets to surge past fears of an incoming slowdown.
Several markets, including commodities, began the year on the defensive with growth concerns and Federal Reserve-led liquidity tightening raising concerns about the prospects for 2019. The year, however, was only a few days old before global policy panic set in with the Fed hitting the pause button in early January before calling a halt to further quantitative tightening at the end of the quarter.
As a result, the market has gone from expecting two rate hikes to an 80% probability of a cut before year-end.
The Bank of Japan and the European Central Bank followed suit with its own measures, while in China the government stepped in with various policy moves to stabilise its economy. The chance of a trade deal between US and China helped sentiment further.
Growth concerns and a flattening yield curve (which raises the risk of recession) provided some sporadic support to precious metals which otherwise were held down by surging equities and the consequent reduced demand for safe-havens and diversification.
Instead, it was the growth-dependent sectors of energy and industrial metals that provided most of the gains. Surging stock markets, Opec production cuts and Chinese stimulus helped to support a strong quarter for the energy and industrial metal sectors.
The agriculture sector was mixed with the US-China trade dispute as well as surging stocks providing continued headwinds. Some uncertainty about growing conditions ahead of the Northern Hemisphere Q2 planting season, however, provided some support. Arabica coffee hit a 14-year low as it continued to suffer from a weak Brazilian real and high Brazil output.
The uncertainty related to the outlook for agricultural commodities helped drive a record hedge fund short across key agriculture commodities. This development combined with a potential change in the fundamental and/or technical outlook could provide the sector with the tailwind to make up for lost ground into the second quarter.
The chart below shows the net position held by hedge funds across key commodity futures:
While falling bond yields and an 80% probability of a US rate cut before year-end are supportive, the other two engines – stocks and the dollar – have both been sputtering. Stable to higher stocks reduce the demand for alternative or safe-haven assets while the dollar has continued to recover from its post-FOMC sell-off. Growth concerns remain a key focus and one that could reduce the appeal for stocks if it deteriorates, as well as weakening the dollar and lending a hand to gold.
Underlying demand through exchange-traded products remains healthy with total holdings on the rise since early March. Hedge funds, meanwhile, continue to struggle and constantly have to adjust their leveraged exposure. The increase in bullish gold bets in the run-up to, and immediate aftermath of, the March 20 FOMC meeting and subsequent price drop has left them underwater with most of that position.
With the uptrend from early March broken, the risk of a deeper correction has once again emerged. The key level of support remains around $1275/oz, the 38.2% Fibonacci retracement and the January low.
Once $1,500/oz broke, the floodgate opened and the dismal liquidity in this metal became apparent. However, finding support ahead of $1,285/oz on the June futures tells us that this was nothing more than a weak correction within a strong uptrend, no matter how painful it seemed.
Opec and Russia are for various reasons very unlikely to reverse the current course of keeping production tight. The Q4 collapse last year occurred after Opec, led by Saudi Arabia, ramped up production in the belief that Iranian exports would collapse. Instead they were wrong-footed by Trump’s waivers which helped trigger the December collapse.
With supply being cut, the biggest risk to oil is renewed worries about global growth and demand. This focus, however, will be kept down as long global stocks continue to rally like they did this past week on renewed trade deal and rate cut hopes.
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