Head of Commodity Strategy
Summary: Commodities had a strong end of August, supported by tightness across the energy market and China stepping in to support its ailing economy. In addition, precious metals received a boost from a ‘bad news being good’ situation, after weaker than expected economic data reignited speculation that policymakers in the major economies are nearing the end of their monetary tightening cycles.
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Following a robust recovery in June and July, the commodity sector turned more defensive last month, especially during the first half when the prospect for even higher US Fed Funds rate for longer drove the yield on 10-year US Treasury bonds to a 2007 high, and together with China growth worries, these sent most commodities, except a few fuel products, lower. The past couple of weeks, however, have seen a marked improvement in sentiment with all commodities, bar a few trading higher, cutting the monthly loss for the sector to less than one percent. The changing mood across financial markets and commodities towards the end of the month were driven by a ‘bad news being good’ situation, after weaker than expected economic data reignited speculation that policymakers in the major economies are nearing the end of their monetary tightening cycles.
The agriculture sector traded mixed in August with the softs sector trading higher as La Niña weather worries started to take its toll on the supply outlook for coffee and not least cocoa which reached a 12-year high at $3677 per ton, a year-on-year increase of 60%. At the other end of the table, the grains sector lost 4.9% with losses in wheat and corn being only partly offset by a hot-weather boost to soybean prices. With the US harvesting season fast approaching, the uncertainty regarding yield and production has started to fade, and with strong export competition from South America for corn and Russia for wheat, these two key crops spent the month drifting lower.
The precious metals sector ended down 1.7% on the month but well off their lows following an end of month rally that was supported by short covering from hedge funds in response to weaker-than-expected US economic data boosting speculation about peak rates and a return to a rate cutting cycle sooner than expected. An end of month recovery across the industrial metal sector reduced the monthly loss to 4.7% after Chinese authorities made steps to support the property sector, as well as the stock market, and not least its currency which at one point this past month approach the all-time high from last October.
Finally, the energy sector, rangebound most of the month, still managed a 2.4% gain with all five futures contracts, including natural gas, showing strength. Natural gas traded higher amid unseasonal hot weather-related demand from power plants while crude and fuel prices traded higher for a third month in response to a tightening global inventory outlook driven by continued OPEC+ production cuts while demand has yet to show any signs of slowing despite the prospect for weaker growth in the months ahead.
Crude oil has reestablished fresh upside momentum after the early August correction ran out of steam before damaging the technical setup, something that is important for technical focused traders who in recent month bought WTI and Brent futures amid the outlook for a tight supply following Saudi Arabia’s decision to cut production by 1 million barrels a day from July onwards. With Brent prices still trading below $90, the prospect for those barrels returning to market anytime soon looks slim and the impact is increasingly being felt across the world as commercial stock levels of crude and fuel products continue to drop.
In the short term production cuts, not only from Saudi Arabia, but also from Russia and others will help support tight market balances in the coming months, especially if China successfully manages to stabilize its growth outlook. These developments could see Brent challenge $90 soon, but it does not alter our view that rising spare capacity from OPEC producers, because of supply constraint, together with rising exports from countries like Iran and Venezuela who are not restrained by quotas, as well as ongoing demand concerns, may prevent prices from having a sustained move above that level.
Overall, the current market tightness remains in clear display through the elevated backwardation shown across the futures curve, an example being the six-month spread in Brent where traders are willing to pay $3.6 per barrel more for delivery in November compared with May next year. In WTI the similar six-month spread between December and June trades at $4.1 per barrel, the highest level since November.
Precious and platinum group metals (PGM’s) ended August on a much firmer footing than where it started. Selling pressure at the start of the month, especially in gold amid the focus on high funding costs (see below) and the prospect of higher for longer short-term rates in the US, began to reverse after a chain reaction was triggered by China’s efforts to support its economy and its currency. Following a period of weakness, the PBoC (People s Bank of China) and state-owned banks stepped into to support the Chinese yuan, and subsequent strength gave a confidence boost to copper prices which then moved onto silver, and finally to gold.
Following swiftly on we saw weaker than expected economic data change the focus from another US rate hike to a hawkish pause followed by rate cuts around June next year. Indeed with precious metals and platinum group metals showing signs of stabilizing, the attention turned to speculators and the positions they hold across the different metal futures. Surging bond yields and a recovering dollar have, for the past couple of months, been the main drivers behind the weakness across the investment metal sector, and the negative momentum seen during this time has attracted selling interest from hedge funds and other leveraged traders in the futures market. The recent strength has therefore undoubtedly been driven by speculators covering short positions and for the recent recovery to continue, we need to see continued weakness in incoming economic data in order to confirm that a gold and silver supportive peak in rates and yields has been reached.
Saxo maintain a bullish view on gold and silver, and see a fresh record being reached in the coming months. Friday’s US job report did not to dampen expectations for a rate hike pause from the Federal Reserve and it supported a fresh attempt for gold to break higher through an area of resistance around $1950 while silver moved closer to a key area of resistance above $25.
Copper’s steep decline at the beginning of August when the yuan weakened amid worries about the Chinese economic outlook, started to reverse as a catalogue of measures were introduced to support the economy, especially the property sector, stock market and currency. Overall, copper remains the best performing industrial metal in 2023 as a surge in green transformation demand continues to offset a slowdown in construction.
In addition, the lack of big mining projects to ensure a steady flow of future supply continues to receive attention from long-term investors as it supports our structural long-term bullish outlook, not least driven by rising demand for green transformation metals and mining companies facing rising cash costs driven by higher input prices due to higher diesel and labour costs, lower ore grades, rising regulatory costs and government intervention, and notably climate change causing disruptions from flooding to droughts.
We maintain a positive and at this point patient outlook for copper given the reasons mentioned and following the strong bounce this past week the HG copper contract is once again testing the 42-week, equivalent to the 200-day moving average at $3.90, a technical level which if broken may signal additional strength back towards $4.00.
From a flow perspective, demand for ETFs from investors, asset managers and traders continue to be focused on ETFs that offer a broad exposure to the commodity sector. The two UCITS (see below) ETFs attracting the biggest flow, marked in blue, this past month both track the performance of the Bloomberg Commodity Index, our preferred index as it tracks the performance of 24 major commodity futures split almost evenly between energy, metals and agriculture. The motive among those recent buyers is likely driven by the need for diversification and not least expectations or even worries about a tight supply outlook for several key commodities supporting prices despite the risk of an economic slowdown into 2024. Or simply the fact the technical outlook for the index, which hit a low on May 31 following a 25% correction has improved significantly.
At the bottom of the table, we find the major precious metal ETFs where reductions in gold extended to a third consecutive month, during which time total holdings, according to Bloomberg, have dropped by 135 tons to 2794 tons, the lowest since February 2020. In recent updates we have highlighted why asset managers and other potential investors may be focused elsewhere amid the current high opportunity/funding cost for holding gold relative to short-term money market products. The cost of carry or opportunity cost in holding a gold position is equal to storage cost and the interest income, currently above 5%, an investor can otherwise receive on a short-term interest rate instrument like T-bills or a money market product. With that in mind, we believe that many investors have temporarily moved out of gold while waiting for confirmation, rates have peaked before moving back in.
The table above show some of the world’s largest and most actively traded commodity ETFs, their recent performance and notably recent investor flows. There are many ETFs tracking commodities so the list is by no means exhaustive and should primarily be used for information and inspiration.
The first section are UCITS-compliant ETFs and are based on an EU directive that provides a regulatory framework for funds that are managed and based in the EU. A UCITS fund can be marketed to and traded by private investors because it adheres to common risk and fund management standards, designed to shield investors from unsuitable investments.
The second part of the table shows mostly US listed, and therefore non-UCITS compliant ETFs, and it is among this group that we find some of the world’s biggest ETFs in terms of market cap. It is also worth noting that due to changed taxation rules by the US Internal Revenue Service from January 1, 2023, many non-US based banks, including Saxo no longer offer access to cash trading in PTP securities. We chose to show the PTP registered ETFs given the signal value they can provide, but also the fact that traders understanding the added risks of holding leveraged positions can still trade these as CFDs.
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
