The unpredictability of future demand has recently been highlighted by several energy producers which are currently on the receiving end of critical comments from governments – especially the Biden administration which is struggling to gain traction, amid record high fuel prices at the pumps, ahead of the midterm elections this autumn. In defence of not raising capital expenditure towards increased oil production and refinery capacity, most energy producers say that rising sales of electric vehicles is set to cut gasoline market share over the next several years, thereby reducing the appeal of new long-term drilling and refining projects.
The month of June has indeed delivered a sharp turnaround across markets, starting with the higher-than-expected US inflation print on 10 June leading to the first 75 basis point rate hike in decades. With several additional rate hikes to follow, the market has increasingly started to worry that central banks around the world will continue to raise rates. This will be either until inflation is brought under control or something breaks – the latter being the risk of economies buckling under pressure with recession the consequence. For now, at least one element of inflation, i.e., rising input costs through elevated commodity prices, have started to retreat.
During the past week, the focus on a recession accelerated as bond yields tumbled after Federal Reserve chair Powell, in a testimony to the US Senate, accepted that steep rate increases could trigger a US recession while making a soft economic landing “very challenging” to achieve. This was followed up by another batch of weak economic data from the US and Europe showing manufacturing and services activity cooling. In Europe, the yield on two-year German bonds tumbled the most since 2008, with the region looking increasingly at risk of a sharp slowdown as the cost of gas and power surged higher after Gazprom cut supplies to Germany.
The mentioned worries about global growth helped push the Bloomberg Commodity Index to a four-month low this past week, with all sectors led by grains suffering setbacks. Since reaching a record peak on June 9, the index has fallen by around 12%, but remains up around 21% on the year with crude oil and fuel products having provided the bulk of those gains. As per the table above, weakness has emerged across all sectors since that day, with EU natural gas the only market being supported by the risk of shortages over the coming months.
Crude oil showed signs of stabilizing on Friday following a near 15% top to bottom correction during the past ten days on increased concerns that aggressive rate hikes by central banks around the world will eventually hurt growth and, in turn, demand for key commodities from energy to industrial metals. Prices have dropped despite continued signs that the crude oil and the fuel product market remains very tight – the latter being highlighted through near record refinery margins, which would have come down if demand was easing. In the short term, we will see a battle between macroeconomic focused traders, selling “paper” oil through futures and other financial products as a hedge against recession, and the physical market where price supportive tightness remains.
Copper was heading for its biggest weekly loss in a year as global recession fears increased and China’s lockdowns continued hurting growth and demand in the world’s biggest consumer of industrial metals. While the Bloomberg Industrial Metal Index trades down 6% on the year, copper is currently 15% under water – with around half of that loss realised this past week when Fed chair Powell reiterated his commitment to bring down inflation, thereby raising the risk of a hard landing. In addition, Codelco, a large mining company based in Chile, has reached an agreement with workers to end a strike that could have led to a price-supportive reduction in supply.
Our long-held bullish view on copper and industrial metals have not changed, but rapid rising recession worries combined with China’s ongoing and prolonged struggle with Covid-19 outbreaks may delay the inevitable move towards a balanced market and eventually a market in short supply. In addition, we are seeing a continued disconnect between sharply lower prices and stock levels held at warehouses monitored by exchanges in London and Shanghai. This past week stocks of all the four major metals dropped to a fresh combined record low at 1.1 million tons, down 60% from a year ago.
Having broken below $3.95 per pound, a level that has been providing support since early 2021, the next key level of support can be found at $3.50/lb, the 50% retracement of the 2020 to 2022 rally.