WCU: Commodity market’s reaction to Russian invasion
Head of Commodity Strategy
Summary: The commodity sector continued its ascent this past week with the Bloomberg Commodity Spot Index reaching a fresh record high on Thursday after Russia’s unprovoked attack on a sovereign nation saw volatility jump across most asset classes. Commodities depending on supply from Russia and Ukraine led the charge and combined with an already tight supply outlook, the sector once again showed its geopolitical and safe-haven credentials.
The commodity sector continued its ascent this past week with the Bloomberg Commodity Spot Index reaching a fresh record high on Thursday after Russia’s unprovoked attack on a sovereign nation saw volatility jump across most asset classes. The stock market suffered steep losses while investors looked for shelter in bonds, the dollar, and not least commodities where an already tight supply outlook supported the sector's geopolitical and safe-haven credentials.
Ahead of the weekend, the across market temperature was lowered after a fresh round of sanctions by Western nations stayed clear of impacting Russia’s ability to produce and export commodities such as crude oil and gas. As mentioned, the Bloomberg Commodity index rose with gains seen across all sectors, with the exception of softs. The biggest moves involving gas, crude oil and wheat, all commodities where a prolonged conflict could impact supply from Russia and Ukraine.
Dutch TTF gas futures saw the biggest impact of the increased tensions with Europe depending on Russia for 40% of its supplies, most of which is being transported through major pipelines including one cutting through Ukraine. Following an initial panicky reaction which saw the price jump above €140/MWh, gas then spent most of Friday trading back below €100/MWh, still a very high price that will continue to negatively impact European consumers and energy intensive industries, not least those producing other raw materials such as aluminum, as well as producers of automobiles, machinery and chemicals.
Germany and Italy are the two major European countries relying mostly on supplies from Russia and with a high percentage of Germany’s export being very energy intensive to produce, it is currently seeing an economic slowdown with Producer Prices running at 25%, its highest annual increase since 1949.
The current extreme volatility is driven by traders’ attempts to price in the risk of Russia making further reductions in their supplies to Europe, a fear that was temporarily reduced on Friday when Gazprom increased supplies due to increased demand from European buyers. The long-term prospect for gas prices to come down looks increasingly limited with the Nord Stream 2 pipeline staying closed indefinitely, and in the event of a prolonged disruption, EU gas inventories cannot be rebuilt before next winter, and as a result the winter 2022/23 TTF gas price currently trades close to €100/MWh, more than six times higher than the long-term average.
Crude oil experienced another week of wild swings with the initial but later deflated threat of Russian supplies being curbed due to sanctions driving Brent crude oil above $105 and WTI above $100 for the first time in seven years. After surging 15 dollars in a matter of days, crude oil then gave back more than half of those gains ahead of the weekend after US sanctions stayed clear of targeting Russia’s ability to export crude oil. In addition, traders had to deal with the potential impact of another release of oil from US strategic reserves as well as ongoing Iran nuclear talks where an agreement would increase supply.
OPEC+ meets next week but at this stage the group has shown no inclination to increase production, primarily due to the fact many producers are already struggling to reach their production targets while Russia, if allowed, is likely to hit its production limit within months. With this in mind, the oil market is likely to remain supported with an easing of tensions unlikely to send prices down by more than ten dollars.
With Saudi Arabia being one of the few producers with a meaningful amount of spare capacity not showing any willingness to add additional supplies, the market has increasingly turned its attention to Iran and renewed efforts to revive the nuclear accord. An agreement could according to the IEA add 1.3 million barrels per day, an amount that would help stabilize but probably not send prices lower.
Global oil demand, barring any sharp economic slowdown, is not expected to peak anytime soon and that will add further pressure to available spare capacity, which is already being reduced monthly, thereby raising the risk of that current high and even higher prices will remain for longer.
Gold traders experienced a very bruising day on Thursday with gold tumbling close to 100 dollars after surging to a 17-month high. A combination of a heavy overbought market running out of momentum ahead of $2000, fears Russia would need to sell gold to prop up the ruble and President Biden’s sanctions underwhelming the market in terms of impact, helped trigger the turnaround with crude oil and bonds selling off and the stock market rallying.
Besides the hard-to-quantify geopolitical risk premium currently present in the market, we maintain our bullish outlook in the belief inflation will remain elevated while central banks may struggle to slam the brakes on hard enough amid the risk of an economic slowdown. We believe the Russia-Ukraine crisis will continue to support the prospect for higher precious metal prices, not only due to a potential short-term safe-haven bid which will ebb and flow, but more importantly due to what this tension will mean for inflation (Up), growth (Down) and central banks’ rate hike expectations (Fewer).
In the short-term, however, the technical outlook has deteriorated to the point that a break below $1877 could see it trade lower towards the next key area of support around $1800.
Wheat: As Russian troops, tanks and missiles entered Ukraine, global wheat prices leapt to a record with other key crops such as corn and edible oils also receiving a strong bid. These developments helped drive the Bloomberg Grains Index higher by 4% on the week, thereby outperforming the energy sector. Paris and Chicago traded wheat futures jumped by more than ten percent with a disruption to shipments from the Black Sea region as well as potential risks to this seasons harvest in a Ukraine known as the “breadbasket of Europe” raising the prospect for even higher food prices.
However, with Ukraine having already shipped two-thirds of its intended exports by November last year, the short-term impact should be limited. With that in mind, the focus will be turning to this year's harvest and with the global market for wheat, just like many other commodities currently being as tight as it is, any disruptions or reduced crop will be felt across the world.
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