WCU: Virus and election jitters slam brakes on commodities

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector has seen a sharp reversal this week from the strong gains recorded during the past couple of months. Faced with a renewed surge in Covid-19 cases in Europe and the U.S. as well as next week's ultimate risk event, the U.S. presidential election, it is perhaps not that surprising to see investors turn more defensive.


The commodity sector has seen a sharp reversal this week from the strong gains recorded during the past couple of months. Faced with a renewed surge in Covid-19 cases in Europe and the U.S. as well as next week’s ultimate risk event, the U.S. presidential election, it is perhaps not that surprising to see investors turn more defensive.

Up until recently, the potential reflationary impact of a Biden win, global weather worries and strong Chinese demand had provided strong fundamental support for metals, both precious and industrials as well as key crops, while crude oil traded sideways with fuel demand worries being off-set by lower OPEC+ production.

The rise in risk adversity, which saw the S&P 500 lose around 5% while the dollar rose 1%, put an end, at least temporarily, to these developments and it helped drive the Bloomberg Commodity index lower by 2.5% with fuel and grain contracts the hardest hit. With regards to the grain sector, one of the best performing sectors in recent weeks, it highlights the risk when positions become too elevated in a period of lower risk appetite.

Crude oil took a tumble to record its worst month since March this year with rising fuel demand worries in virus-hit regions and rising production from Libya attracting more attention than robust demand from Asia and a growing belief that OPEC+ will postpone the agreed January production increase.

Brent crude oil tumbled below $39/b support in response to a bigger-than-expected jump in U.S. stockpiles and renewed lockdowns being introduced in France and Germany with other European countries set to follow suit during the coming week. Overall however, we suspect that a combination of long liquidation having run its course and vocal intervention from OPEC+ ahead of $35/b, may prevent the price from falling much further.

Source: Saxo Group

These latest developments add up to an immediate future where investors are more concerned about capital preservation than capital gains. With this in mind, we find the commodities most at risk being the ones where speculators are holding large and mostly long positions as the focus switches from a long-term bullish outlook to a short-term and more defensive attitude. These developments have seen the grain and fuel sectors suffering the most while metals, both precious and especially industrials, have seen sharp reversals.

In recent weeks, the aforementioned supportive fundamentals helped drive strong demand for futures from leveraged funds and CTAs. In the latest COT report covering the week to October 20, the combined net long across 24 major futures markets reached 2.3 million lots, the highest since February 2017. New multi-month highs were seen in natural gas, HG copper, soybean meal, corn, Kansas wheat, sugar and cotton while strong buying was also seen in crude oil and gold. In grains, the combined net long across six soy, corn and wheat contracts reached 702,249 lots, the highest since 2012. A clear reflection of the strong underlying fundamental support but equally a warning sign that any short-term change in the outlook carries the risk of a correction.

The table below highlights the speculative long/short and net positions held by large speculators such as hedge funds and CTA’s across key commodity futures. Data is compiled by the U.S. CFTC and released every Friday with data to the previous Tuesday. The coloured numbers in the net column show net positions at a +12 month extreme.  

    Take gold as another example of a market where the outlook has been and continues to be overwhelmingly supportive. After hitting a $2075/oz record high in early August, gold has spent the past three months drifting lower. This lack of performance has, however, not deterred investors as they continued to increase exposure, primarily via exchange-traded funds backed by bullion.

    In our latest gold market update we warned that gold was not ready for an election shock or other adverse developments. This was a conclusion we made after taking a closer look at activity in the options market ahead of the U.S. election, which in terms of risk events, doesn’t come much bigger. An overview of the most actively traded options in GLD:arcx and GDX:arcx, the biggest gold and gold miners ETF’s found, perhaps not surprisingly but also somewhat concerningly, an overwhelming focus on the upside via calls. With such an overwhelmingly bullish view on the market, the risk of an adverse reaction rose to the point where renewed stock market weakness and a stronger dollar helped send not only metals, but most commodities lower. 

    However, looking at the gold chart we have yet to see a trend that raises concerns about a deeper and more prolonged sell-off. Despite the latest bout of weakness, the metal has not yet tested the September low at $1849/oz, let alone $1837/oz, the 38.2% retracement of the March to August rally. We view the current correction as temporary with rates at rock bottom low levels and continued fiscal and monetary intervention providing the support needed for gold. With that, we also expect to see silver trade higher once the election jitters have died down.

    Source: Saxo Group
    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 is not intended to and does not change or expand on this. 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-hk/legal/disclaimer/saxo-disclaimer)

    Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong

    By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

    Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

    Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.