Head of Commodity Strategy
Summary: The Bloomberg Commodity Index traded lower for a second week with lower risk appetite, as seen through the setbacks among U.S. megacap stocks, combined with a dollar that has stopped falling, rising coronavirus cases and concerns about the timing of a vaccine all playing a part. Crude oil and fuel products took a hit on weakening fundamentals while grain markets held their recent strong gains. Precious metals continued to consolidate with platinum the best performing metal on the week.
The Bloomberg Commodity Index, which tracks a basket of major commodities spread evenly across energy, metals and agriculture, traded lower for a second week. Risk appetite, as seen through the behavior among U.S. megacap stocks, has received a setback following the flurry of activity during July and August. This development, combined with a dollar that has stopped falling, rising coronavirus cases and concerns about the timing of a vaccine, have all played a part.
The hardest hit during the past week was the energy sector, which amid rising signs of wavering fuel demand, began seeing the price of oil and fuel adjusted lower to better reflect current fundamentals which are showing signs of weakening. The grains sector maintained strong momentum ahead of Friday’s U.S. Government report, which was expected to confirm a lower production due to adverse weather and lower ending stocks as a result of very strong demand from China.
Precious metals continued their consolidation within a relatively wide range, with gold and silver trading higher on the week. Signs of deteriorating relations between the U.S. and China, together with continued demand for inflation hedges as seen through the strong demand for gold via exchange-traded funds, helped to offset headwinds created by the general reduction in risk appetite.
At the top of the table this week we find platinum, which normally operates in gold’s shade. In their latest quarterly update the World Platinum Investment Council (WPIC) revised their 2020 outlook from a surplus to deficit. In it, they explain the changes caused by the pandemic which have reduced access to recycled material as well as supplies from South Africa, the world’s biggest producer - adding to heightened global risk which they, as well as Saxo Bank, expect will continue to drive investor demand for hard assets.
Platinum has, since the diesel scandal a few years ago, seen its spread to gold go from a premium to the current discount of more than 1000 dollars per ounce. While gold has reached a record high, platinum as well as silver (another semi industrious metal) remain well below their record highs. Platinum hit a $2300/oz peak in early 2008 before collapsing 68% during the Global Financial Crisis later that year.
From an investment perspective, platinum’s biggest challenge remains its lack of liquidity, being a much smaller market than gold. This is one of the likely reasons why it, despite an improved outlook, has seen a muted demand from asset managers who operate in sizes which platinum would struggle to manage.
The key area of resistance is currently between $1000/oz and $1040/oz where it has been rejected on several occasions during the past three years.
Agriculture: The grain sector has seen strong gains during the past five weeks with weather concerns, the weaker dollar and strong Chinese demand all having helped create a bullish backdrop. The combined long in Chicago traded corn, wheat and soybeans futures reached 214,000 lots during the week to September 1, some 325,000 lots above the five-year average seen for this period. This is interesting, because it is normally a time of year when funds tend to be net sellers given the lack of unknowns ahead of the arrival of the new harvest.
With these developments in mind, the market was looking ahead to Friday’s monthly update on production, yields and stocks from the U.S. Department of Agriculture. In the World Supply and Demand Estimates (WASDE) – released after writing this - grain traders were looking for data to support the recent strong rally and elevated longs across the sector.
Crude oil remains under pressure from weaker fundamentals as the recovery in global energy demand continues to show signs of stalling. Many countries around the world, especially in Europe and Asia, are now in the midst of a second wave of coronavirus. As a result, the recovery in fuel demand has stalled with work-from-home and the lack of leisure and business travel - both signs that it will take longer than anticipated to get back to a pre-virus levels of energy demand.
During the period of sideways trading since June, data from the physical market had begun sending signals that the price and current fundamentals were moving out of sync. Among others, we have seen a rising contango with spot prices trading at a deepening discount to the next month(s) as storage tanks fill up in response to weak refinery margins, primarily due to an overhang of unwanted diesel and jet fuel. These developments have led to rising demand for tankers toward floating storage trades, while Saudi Arabia has reduced its official selling price for October as demand from key customers such as China begin to weaken.
What it took for the correction to occur was a deterioration in the overall risk appetite as seen through the correction in U.S. (tech) stocks and the dollar being bought. In Brent crude oil, the break of the uptrend from June was the technical trigger, which finally kicked off a move to bring price and fundamentals more in line.
We do not believe that we will see a new dramatic sell-off in crude oil, but have to accept that the coronavirus and doubts about the timing of a vaccine may continue to delay until next year the recovery back towards $50/b on Brent crude oil. The slowing recovery in demand will challenge the resolve of the OPEC+ group which in hindsight increased production before demand had recovered enough to absorb the additional barrels.
Fundamental oil market guidance will be provided by OPEC and the International Energy Agency when they publish their monthly oil market reports on September 14 and 15 respectively.
Brent has found support at its 100-day moving average at $39.50/b but with speculators only just having started to reduce bullish bets, the correction may take it down to towards $36.50/b before support can be established. The general level of risk appetite through stocks and the movement of the dollar will continue be a key source of inspiration for traders.
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