Head of Commodity Strategy
Summary: The commodity market focus continues to alternate between supporting supply disruptions and the risk of lower demand driven by prolonged lockdowns in China hurting growth, and not least central bank efforts to combat inflation levels not seen since the 1980’s. If the latter was the only focus, a peak in commodities would be near, however we see an equally challenged supply side keeping the sector supported for a prolonged period of time
There is little doubt that recent very strong readings on growth and employment will start to be negatively impacted over the coming months by persistently-high inflation and rising rates. If that was only the focus on commodities, the peak would be in by now and lower prices could be expected during the coming months. However, we believe commodities will continue to be supported as supply is likely to be equally or perhaps even more challenged than demand. Sanctions against Russia, now a pariah nation to much of the world, are unlikely to disappear once peace returns to Ukraine.
Being the world’s second largest exporter of commodities from energy to metals and agriculture, consumers and industries around the world will continue to struggle sourcing the raw materials needed. In addition, recent weak first-quarter trading updates from the biggest mining companies, such as BHP, Vale, Rio Tinto and Anglo American, have all highlighted the challenge they face with the rising cost of everything from steel and diesel to labor, as well as social unrest and troubled weather. All factors that have seen production fail to meet expectations.
Copper, as an example, remains range-bound and while the short-term demand outlook has worsened and inventories at exchange-monitored warehouses have risen during the past four weeks, the outlook in our opinion remains price supportive. The demand for action to isolate Russia through a reduction in dependency of its oil and gas is likely to accelerate the electrification of the world, something that requires an abundant amount of copper.
Chile, a supplier of 25% of the world’s copper, have seen production slow in recent months, and with an “anti-mining” sentiment emerging in the newly elected government, the prospect of maintaining or even increasing production seems challenged. In addition, Chile has entered its 13th year of drought and water shortages are having a major impact on the water-intensive process of producing copper. In addition, government legislation has been put forward to prioritize human consumption of water, and if voted through it may delay investment decision but also force mining companies to invest in desalination facilities, thereby raising the cost of production further.
Crude oil continues to trade within a narrowing range around $107 in Brent and $102.5 in WTI. Beneath the surface, however, the market is anything but calm with supply disruptions from Libya and Russia currently being offset by the release of strategic reserves and lower demand in China where officials are struggling to eradicate a wave of Covid-19 in key cities. In addition, the market is on growth alert with the US Federal Reserve signaling an aggressive tightening mode in order to curb inflation, a process that most likely will reduce growth and eventually demand for crude oil. US refinery margins hit a record earlier this week before falling by more than 10%, developments still reflecting the high prices global consumers are forced to pay as supply of key fuels, such as diesel and gasoline, remain tight due to reduced flows from Russia.
Next week, the focus will turn to earnings from the oil supermajors such as Exxon Mobil, TotalEnergies and Chevron. Apart from delivering eye-watering profits the market will mostly be focusing on the prospect for increased production and how they see the impact of the war in Ukraine, demand destruction from rising prices and monetary tightening.
With the war ongoing and the risk of additional sanctions or actions by Russia, the downside risk to crude oil remains, in our view, limited. In our recently published Quarterly Outlook we highlighted the reasons why oil may trade within a $90 to $120 range this quarter and why structural issues, most importantly the continued level of underinvestment, will continue to support prices over the coming years.
Gold and silver price developments this past week described very well the current drivers impacting markets with gold trading relatively steady while silver saw renewed selling pressure. Despite its recent lackluster price performance, gold nevertheless continues to attract demand from asset managers seeking protection against rising inflation, lower growth, geopolitical uncertainties as well as elevated volatility in stocks and not least bonds.
This past week the market once again raised its expectations for US rate hikes with projections now pointing to three consecutive half-point Fed interest-rate hikes. The quickest pace of tightening since the early 1980’s could see rates higher by 2.5% by December.
Gold’s ability to withstand this pressure being seen as the markets attempt to find a hedge against a policy mistake tipping the world’s largest economy into a downturn. So far, however, the current US earnings season has shown companies are able to pass on higher costs and preserve margins.
With input prices staying elevated due to war and sanctions and a general scarcity of supply, only the killing of demand can bring down inflation. A view that has seen the gold-silver ratio hit a two-month high above 80 with silver underperforming given its semi-industrial status. Total holdings in bullion-backed ETFs meanwhile hit a fresh 14-month high as asset managers continue to accumulate holdings into the current weakness. In addition, signs of strong retail and central bank demand are likely to support gold, despite the recent breakdown in correlation between gold and US ten-year real yields indicating gold on this parameter alone is overvalued.
In our recently published Quarterly Outlook we highlight the reasons why we see the prospect for gold moving higher and eventually reaching a fresh record-high later this year.
Gas prices in Europe have lost some momentum this month with spring and warmer weather reducing demand, thereby sending the price of prompt delivery gas to the lowest level since the start of the war in Ukraine. Low supplies from Russia and a reduction in flows from Norway due to seasonal maintenance has been offset by strong arrivals of LNG shipments and a warm beginning to spring. As a result, storage levels across the continent have started to build almost a month earlier than last year. As Europe steps up its effort to reduce dependency on Russian gas these developments have been met with a sigh of relief, but a long and very expensive road lies ahead for this plan to succeed. In the short term, the market will continue to worry European buyers objection to Russia’s rubles-for-gas order with bills due later this month.
While the front month price of Dutch TTF benchmark gas has dropped to around €100/MWh, still six times the long-term average, the cost of securing gas for the coming winter from October to next March remains stubbornly high around the same level. In other words, the usual profitable trade of buying cheap summer gas to storage in order to sell it at a higher price during the peak winter demand season is currently not working. What it will mean for the speed of stock building remains to be seen.
In the US meanwhile the front month Henry Hub natural gas contract reached a 13-year high around Easter above $8/MMBtu or €25/MWh in European money, before reversing lower on technical selling to the current $7/MMBtu. Strong domestic and export demand together with a shortage of coal are testing drillers’ ability to expand supplies, not least considering a US government pledge to increase exports to Europe. So far, no major pick up in production has been seen, resulting in stockpiles trailing the seasonal average by around 17%.
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