Head of Commodity Strategy
Summary: The mood across financial markets and commodities soured this past week after traders and investors responded negatively to minutes from the latest FOMC meeting suggesting the Fed has not yet done enough to combat sticky inflation. In addition, the Chinese economy which has struggled for months to rebound from the end of strict pandemic controls last year, continued to deteriorate on renewed fears of a further slowdown in the property sector. China-centric commodities sold off as the offshore yuan tumbled toward a multi-year low before the government stepped up their efforts to arrest the slide
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The mood across financial markets and commodities soured this past week after traders and investors responded negatively to minutes from the latest FOMC meeting suggesting the Fed has not yet done enough to combat sticky inflation. In addition, the Chinese economy which has struggled for months to rebound from the end of strict pandemic controls last year, continued to deteriorate on renewed fears of a further slowdown in the property sector, which typically drives more than a quarter of China’s economic activity. China-centric commodities sold off as the offshore yuan tumbled toward a multi-year low before large state-owned banks and the People’s Bank of China (PBoC) stepped up their efforts to arrest the slide.
These developments helped drive broad dollar strength while bond yields approached levels last seen before the financial crisis. Rising yields hurt the prospect for investment metals with gold falling below $1900 while industrial metals, led by copper, took most of their directional inspiration from the ebb and flow of the Chinese yuan. The energy sector lost momentum following a two-month rally, but the current tight supply outlook supported by OPEC+ production cuts will prevent a deeper correction at this stage.
Meanwhile, the agriculture sector stabilized following weeks of weakness with Black Sea supplies still a concern. In the US, expectations for hot weather in late August may still impact the final harvest result. In addition, export restrictions of rice and sugar from India, a major shipper, continue to underpin prices of these two important food items, despite a small setback this past week.
The Federal Reserve’s Economic Policy Symposium in Jackson Hole, Wyoming, is scheduled for August 24-26. This year’s theme "Structural Shifts in the Global Economy" and Fed Chair Jerome Powell is expected to speak on August 25 at 10am ET. Other central bank heads will also be speaking, and from recent commentaries, it appears that central bankers will keep the flexibility to hike rates further, while clearly avoiding committing to cutting rates soon. Still, thoughts on economic momentum, especially the current headwinds, could be key and rising credit risks may warrant some dovishness.
Overall, the Bloomberg Commodity Total Return index traded lower for a third week, surrendering more than one-third of the strong gains achieved following the early June low. Most major commodities and all sectors traded lower, led by softs. Coffee traded sharply lower on increased selling pressure from Brazilian producers as the harvest near completion, thereby easing shortage concerns that in recent months helped underpin the price. Cotton prices also slumped on demand concerns despite the outlook for a much smaller US cotton harvest due to record-high temperatures in the US South.
At the top of the table for the second week we find EU TTF gas futures, a contract which is not a member of the Bloomberg Commodity index. It remains supported by concerns over strike action at three major LNG export facilities in Australia, potentially impacting 10% of global LNG shipments and in the process causing increased competition from Asian buyers for gas otherwise destined for Europe – a region that has become more dependent on LNG imports following a steep drop in supplies from Russia. The latest spike highlights the risk of another volatile winter given the uncertainty about weather and production from renewables.
The energy sector traded lower for the first time in eight weeks as the focus turned to consolidation after the general level of risk appetite took a knock from strengthening macroeconomic headwinds from China growth to rising rate concerns. China, the world’s top importer of crude oil remains a major piece in the oil puzzle, not least considering that the bulk of this year’s robust demand growth forecasts, according to the IEA, is being driven by Chinese demand. So, when it comes to current oil market developments, it is especially important to focus on China for demand and Saudi Arabia for supply with the voluntary 1 million per day production cut likely to underpin the market and prevent a deeper correction at this stage.
On the other hand, rising spare capacity from OPEC producers, as a result of supply constraints, together with rising exports from countries like Iran and Venezuela who are not restrained by quotas, together with the mentioned demand concerns are in our opinion, forces that will prevent prices from a sustained move above $90.
Earlier in the week, Brent and WTI both dropped below their 21-day moving averages, thereby signaling a pause in the strong run up in prices that started in early July following the Saudi production cuts. Together with the loss of risk appetite spreading from the continued rise in bond yields and stock markets suffering broad declines, the focus has shifted to consolidation, but as long Brent holds above $81.75 and WTI above $78 the risk of another round of long liquidation from funds remains limited.
Copper futures in London and New York continue to defy gravity, trading sideways for months while the rest of the industrial metal sector has suffered steep declines amid growth concerns. The Bloomberg Industrial Metal index which tracks the performance of copper with a weighting of 35.9%, aluminium (27.4%), zinc (16.1%), nickel (14.2%) and lead (6.4%) trades down 16.4% on the year and near last year’s low point when China’s prolonged Covid lockdown hurt sentiment and not least demand from the world’s top consumer.
However, while the industrial metal weakness led by nickel and zinc has created a challenging environment for investors, copper remains resilient, and despite an environment of stagnant manufacturing PMIs – normally well correlated with copper demand – Chinese demand has remained surprisingly robust. Not least driven by strong, and government supported, green transition demand towards batteries, electrical traction motors, energy storage and grid upgrades.
Apart from the mentioned weakness in China and global manufacturing PMIs weighing on prices, copper’s very strong correlation with the Chinese Renminbi continues to challenge the metal’s short-term resolve, after the latest rate cuts from the PBoC drove the offshore Renminbi to the lowest level against the dollar since last November before government intervention supported a small bounce and with that, a small recovery in copper.
While low stock levels continue to provide some underlying support, the lack of big mining projects to ensure a steady flow of future supply continues to receive attention from long-term focused investors as it supports our structural long-term bullish outlook, 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 not least climate change causing disruptions from flooding to droughts.
Gold prices remain in a downward trending channel, with a fourth weekly decline in a row, being driven by rising yields and a stronger dollar amid speculation the FOMC may have to hike rates further as incoming economic data points to continued price pressure. As long as this remains the focus, asset managers and other large investors will have their focus 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 an investor otherwise can receive on a short-term interest rate instrument like T-bills or a money market product. So, whether you own physical gold or hold and roll a futures position, there is no escape from the fact that it carries a cost, either through not receiving the +5% through a short-term interest rate instrument or through the roll into a higher priced forward price in the futures market.
While we maintain a bullish outlook for gold, these developments also highlight the risk that gold may continue to struggle attracting demand from investors until something breaks, either through a credit event, a weaker dollar, or the belief the FOMC has switched its focus towards cutting rates. Technical traders are unlikely to offer much support until the downtrend is broken and, until then, gold may be at risk of an extension towards $1865.
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