For a change, the gains this past week were primarily driven by the agricultural sector as the increased risk of another La Ninã event this winter helped drive prices of several key food commodities higher. The energy sector was mixed with crude oil showing signs of pausing as sharply lower gas and coal prices helped reduce the potential support from the gas-to-oil switch which in recent weeks had been suggested could add one million barrels per day of additional demand over the coming months.
Industrial metals ended a wild month by trading lower after having given up some of their recent strong gains amid worries about growth and demand putting a short-term break on an otherwise bullish outlook for the sector. After rallying 15 percent to a record high during the first half of the month, the London Metals Index then spent the second half giving up more than half of those gains. A near halving of coal prices in China also helped support a sharp price drop in aluminum, the most energy intensive metal to produce.
As Bloomberg put it in an update: “The chaos in the copper market this month is a particularly extreme example of the impact that logistics disruptions and a global energy crunch are having on supply across commodities markets. With inventories dwindling, spot prices are trading at steep premiums to futures in five out of the six main LME metals markets, signaling buyers are running short.”
Has the commodity rally ended? While the global growth outlook has started to look more challenging, it is natural to ask the question whether it will be enough to reverse the strong commodity rally seen this year. We do not believe it to be the case with plenty of demand towards to the green transition still waiting to be unleashed at a time when the focus on ESG compliant investments continue to prevent so-called old economy industries, especially within mining and oil production, to attract the funds needed to ensure an adequate level of supply over the coming years.
Commodity prices depend not only on demand but increasingly also on the availability of supply and, with the above-mentioned factors in mind, we are seeing tightness developing across many individual commodities. How tight can be seen in the chart below which shows the percentage difference in the price between commodities for prompt delivery and the one-year forward price. The higher the backwardation, the tighter the market is perceived to be with buyers willing or forced to pay a higher price for immediate delivery.
The prospect of tight gas markets during the northern hemisphere winter has driven the one year spread in US traded natural gas to an extreme of almost 23 percent. Even if we discard natural gas, the average backwardation across five crude oil and fuel product futures has reached more than 9%, a level not seen since at least 2005. Industrial metals, as mentioned, are currently witnessing the same development with the average backwardation across copper, aluminum, nickel and zinc rising to the highest level since 2007.