Head of Commodity Strategy
Summary: The commodity sector traded lower for a second week but overall the month of June ended with the first gain since last November, driven by some very strong gains during the first half of the month. The Bloomberg Commodity Total Return index which tracks the performance of 24 major commodity futures was heading for a monthly gain of 3%, slightly underperforming the MSCI World stock index. Gains were led by grains and energy as hot and dry weather gave key crops and naturalt gas a boost while a Saudi Arabia supply cut helped put a floor under the oil market. Ahead of the second half we take a closer look at events and developments that may help set the tone and direction for several key commodities.
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The commodity sector traded lower for a second week but overall the month of June ended with the first gain since last November, driven by some very strong gains during the first half of the month. The Bloomberg Commodity Total Return index which tracks the performance of 24 major commodity futures spread evenly across energy, metals and agriculture was heading for a monthly gain of 3%, slightly underperforming the MSCI World stock index. Gains were led by the grains sector which at one point traded up 20% before ending the month with a 7.5% gain, driven by a battle between deteriorating crop conditions and beneficial rains spiced with wrongfooted speculators.
The energy sector traded higher by 6.5% led by a 13% recovery in US natural gas, while crude oil managed a 3.5% gain within a well-established range where support is being provided by OPEC production cuts and the upside capped by concerns about demand in the world’s two biggest economies. European natural gas prices meanwhile jumped the most since last July as volatility returned with a vengeance amid unplanned supply disruptions, competition from Asia and heat waves. The industrial metal sector managed a small gain with copper trading higher following a roller-coaster month where the direction was dictated by the ebb and flow of news regarding additional stimulus in China. Precious metals recorded a back-to-back monthly loss as the prospect for higher rates in the US lifted real yields across the curve. Finally, the softs sector suffered another monthly loss, led by sugar and coffee as the supply outlook showed signs of improving.
Two major themes continue to drive the bulk of the price action across energy and metals, both industrial and precious. The first is the impact on global growth from combatant central bankers’ continued attempts to curb inflation though rate hikes. The second is China - the world’s top consumer of raw materials – where a sluggish economic recovery continues to puzzle the market while raising speculation the government will have to step in with additional support.
During the past couple of months, the Citi Economic Surprise Index has shown a sharp divergence in economic data surprises relative to market expectations between the US and China. In the US, economic data has surprised to the upside, most recently with jobless claims showing a continued robust job market while Q1 GDP was revised higher due to higher consumer spending. These developments may force the FOMC to continue hiking rates, potentially hurting growth and demand in the process. The result is sharply higher bond yields, fresh dollar strength and a market pricing in additional rate hikes before year-end. In China meanwhile, the demand outlook remains challenged by a sluggish recovery with economic data continuing to disappoint.
The combination of these developments are the main drag on commodity prices, in some cases reducing the focus on medium to long-term price, supporting supply challenges across several key commodities. The third quarter will likely provide some answers, the most important being whether the Chinese government and central bank will initiate further attempts to support the economy. For now, there is a sense that China is in a wait-and-see mode, waiting for the end of July politburo meeting.
Copper prices traded lower for a second week, hitting their lowest level in more than four weeks as strong US economic data and hawkish comments from several central bank heads led by Fed Chair Jerome Powell capped risk appetite. Apart from growth concerns, the various stimulus measures announced by the Chinese government and the People’s Bank of China, have so far left the market unimpressed by their potential. Helping to cushion the fall – which gained some momentum following the slide back below the 200-day moving average currently at $3.8250 in the High Grade futures contract – has been a continued drop in copper stocks monitored by the major futures exchanges in London, New York and Shanghai. A seventh weekly decline has seen the level drop to 242,000 tons, the lowest since last December.
Additional Chinese stimulus or not, we continue to see a clear path towards higher prices in the coming years as the importance of the green transformation theme and its impact on several so-called green metals will continue to provide a strong tailwind, especially for copper, the best electrical-conducting metal for the green transformation - including batteries, electrical traction motors, renewable power generation, energy storage and grid upgrades. Producers will face challenges in the years ahead with lower ore grades, rising production costs and a pre-pandemic lack of investment appetite as the ESG focus reduced the available investment pool provided by banks and funds.
Having dropped back below the 200-day moving average, copper may settle into a period of rangebound trading while we await further news on Chinese stimulus initiatives, and watch the general level of risk appetite. Key support is the May low at $3.545/lb.
A quarter that delivered two major OPEC production cuts did not prevent crude oil from extending its run of quarterly losses amid an ongoing rate hike cycle leading to growth and demand concerns. Combined with China’s sluggish economic recovery, the price of Brent remains anchored in the 70’s while OPEC, led by Saudi Arabia, would ideally have liked to see it back to the 80’s. For now, prices remain rangebound with Brent trading within a seven-dollar wide range between $71.50 and $78.50, and after seeing another selling attempt though support run out of energy, prices did rise slightly on Thursday in response to stronger than expected US economic data and a weekly inventory report showing a big drop in crude oil stocks while implied demand for gasoline and jet fuel remain robust.
We still see the potential for the coming quarter either making or breaking the crude oil market. This depends on whether OPEC and the IEA’s lofty demand growth forecasts will be met or whether – as the Saudi unilateral production cut from July tried to preempt – we could see economic activity slow to an extent that prices suffer further declines. It would be interesting to see how OPEC handles such a situation, not least Saudi Arabia. Having already cut production, and thereby giving up market share to support the price, the Kingdom is likely to apply intense pressure on other producers to make additional cuts.
At Saxo, however, we believe a US recession will be avoided and that China will step up its efforts to support the economy, but whether this will be enough to support higher prices through a tightening market remains to be seen. For now, we are left with a market where macro-focused funds once again prefer to trade the oil market from a short perspective as a hedge against further economic weakness.
In the short term, we are watching OPEC’s focus on supply management, which for now has kept the market supported above $70, while an upside break seems equally unlikely if the focus remains on a weakening economic outlook. From a technical standpoint, the $80 area in Brent will offer a great deal of resistance and funds positioned for additional weakness are unlikely to change their negative price view until we see the return of an 8-handle.
An impressive bull versus bear battle broke out in gold on Thursday after stronger than expected US jobless claims and GDP data triggered a sell-off below the key $1900 level in cash and $1910 in futures. The break to the lowest level since March, however, saw buyers return and following a battle that saw more than 6 million ounces trade in the August futures contract, the price recovered to force a fresh round of short-covering. In the short-term, the prospect for more US rate hikes combined with rising US real yields to or near cycle highs may pose a continued challenge to gold.
A peak rate scenario will, in our opinion, continue to be the event that triggers the next upward extension in precious metal prices. Given the latest signal from the US Federal Reserve that this timing has once again been delayed, the market response in the coming weeks will continue to be very data dependent – as any signs of economic weakness will impact how the market prices the prospect for rate hikes.
For several reasons highlighted in previous updates and despite the current setback, we maintain a long held positive outlook for gold. For now though, gold remains stuck in a downtrend with a break above trendline, and the 21-day moving average around $1940 needed to change that.
The most intense drought to hit the U.S. Midwest farm belt since 2012 deepened in recent weeks, sapping soil moisture and threatening crop yield potential in the heaviest corn and soybean production areas of the United States. Grain prices nevertheless gave up most of their recent strong gains amid the outlook for a series of rainstorms forecast over the next two weeks potentially stabilizing and improving crop conditions. The +6% rain-driven slump in the Bloomberg Grains Index this past week has likely been accelerated by selling from speculators exiting recently established and now loss-making longs. Apart from watching grain conditions, the next update is due Monday, and the market will also be turning its attention to key acreage and stocks data due on June 30.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
