Equities: New extremes and a challenging opportunity set
Discover insights on the future of equity markets in Q1 2024 and navigate the potential recession with strategic investment choices.
Head of Commodity Strategy
Summary: The commodity sector continued to find support this past week, despite the hurricane sweeping across global stock markets where the S&P 500 so far has recorded its fourth biggest drawdown since 2010. Gains this past week were concentrated in industrial and precious metals - sectors that have suffered setbacks during the past two months. In addition, the risk of a global food crisis continues to support the agriculture sector while a tight fuel-product market kept crude oil range bound despite economic growth worries.
The commodity sector continued to find support this past week, despite the hurricane sweeping across global stock markets. US stocks posted their biggest daily drop in almost two years on Wednesday, driven by surging inflation, weak earnings and the prospect of aggressive monetary policy tightening hurting economic growth. Nevertheless, the Bloomberg Commodity Spot index managed to climb by 1.6% and, while we are seeing the fourth biggest drawdown in the S&P 500 since 2010, the commodity sector continues to highlight the need for both supply and demand to keep prices stable.
With the supply of many key commodities – from grains and coffee to fuel products and some industrial metals – being challenged, the sector is likely to remain supported despite softer growth; especially considering the prospect for a government-supported stimulus boost to a post-lockdown China. Growth in the country has been increasingly challenged by its stubborn adherence to the dynamic zero-Covid policy despite mounting economic and social costs.
Gains this past week were concentrated in industrial and precious metals – sectors that have suffered setbacks during the past two months. In addition, the risk of a global food crisis continues to rise, with Russia’s aggression in Ukraine and poor weather conditions being the main culprits for the disruption to a lower supply of key food commodities.
The grains sector hit a fresh record high with the Bloomberg Grains Spot Index sprinting to a +30% gain on the year. Soybeans led the rally, followed by wheat with corn registering a small loss in the week. Global worries about a food crisis persist with disruptions in shipments from the Ukraine, one of the world’s most important supplier of high-quality wheat and sunflower oil causing ripples around the world. Ukrainian farmers have almost completed the sowing of spring wheat for the 2022 harvest and the overall rate of this year's spring crop sowing is 25% lower than at the same date in 2021, the agriculture ministry said on Friday.
A couple of positive supply news, however, helped ease but by no means remove worries about a global food crisis. Palm oil slumped after Indonesia ended its short-lived export ban. Wheat which earlier in the week surge to fresh highs in Europe and the US on worries about supplies from India saw prices ease on forecast for a bumper crop year in Russia. However, comments from agriculture analysis firm Gro Intelligence that the world only has 10 weeks’ worth of wheat consumption in reserve will keep prices supported. At least until we get some more clarity over production levels in Europe and North America, both areas that have seen a challenging weather-related start to the growing season.
In our latest industrial metal-focused update, we wrote that the precious metals sector was looking to China for a rebound and, indeed, this week saw some of the signals that China is starting to turn more supportive. Before then, the Bloomberg Industrial Metal Index had lost 25% since the early March peak, with the main catalysts – aside from global growth worries – being China and its zero-Covid policy. Outbreaks in Shanghai and Beijing have been met with a prolonged period of lockdown, hurting economic growth and creating major bottlenecks across global supply chains.
This week in China, we saw retail sales slump 11% and youth unemployment hit a record 18.2%, as well as economists forecasting downgraded GDP. Responding to these developments on Friday, Chinese banks cut their 5-year loan rate by a record 0.15 basis points. Keep in mind, this is happening while the rest of the world is going in the opposite direction, and it highlights the Chinese government’s willingness to support the economy. More support will likely follow as the government seeks to support infrastructure and property projects, which are both critical for industrial metal demand.
Around the timing of the early March peak in prices, stock levels of the four major industrial metals held at warehouses monitored by the LME and Shanghai Futures Exchange stood at 1.77 million tons. Instead of rising as demand according to the price action showed weakness, this level has continued to fall, reaching 1.43 million tons this week – a 19% decline during this time.
It highlights our view that a global economic slowdown does not prevent industrial metals from moving higher, despite supply potentially struggling to keep up with demand not only from China, but also from the energy transition away from fossil fuels. A transition that, in name, is green but actually is very black when you consider the number of different metals that are needed in the process. These range from aluminum, copper and nickel to more exotic metals like rare earth minerals, cobalt and lithium.
High-Grade Copper: Despite the month-long correction, HG copper remains rangebound, having so far failed to properly challenge key support in the $4 per pound area. As it stands, the recovery this week has taken HG copper back to its 21-day moving average, with a break above signaling a loss of negative price momentum. If realised, it may soon force speculators to cover a net short which, in the week to May 10, doubled to reach a two-year high at 17.7k lots or 201k metric tons.
Gold, in a downtrend since mid-April, found a fresh bid amid continued turbulence across global stock markets. During the past month, gold suffered from the double blow of a stronger dollar and the FOMC signaling an aggressive pace of future rate hikes to combat inflation at the highest level in decades. This is fine if the economy does not suffer too much of a setback, thereby raising the risk of recession. What changed this week has been dismal earnings news from large US retailers raising the risk of a deeper than expected economic slump.
We maintain a bullish outlook for gold, given the need to diversify amid a troubled stock market and the mentioned potential increased risk of a FOMC policy mistake driving yields and the dollar lower. From the chart below, gold has its work cut out, and a great deal of work is needed to mend the damage done during the past month. However, the first sign of improvement has been the break above the 200-day moving average at $1839 – with the next big challenge being $1868, the 38.2% retracement of the 210-dollar April to May correction.
Silver, supported by the bounce across industrial metals, seems to have found its footing following a 22% correction, which – at one point – extended below previous support around $21.50. With speculators having cut their positions to neutral, any renewed upside momentum is likely to attract fresh buying from underexposed funds.
Crude oil spent most of the week challenging the upper end of the trading range that has prevailed for the past six weeks. However, relative calm market action during this time has been hiding a market in continued turmoil where major opposing forces have managed to keep it rangebound. During this time, the U.S. government has injected millions of barrels in a failed attempt to suppress the price while Chinese demand has suffered due to its zero-Covid strategy.
The fact the market has not fallen below $100 highlights the underlying strength with tight supply of key fuels, self-sanctioning of Russian crude oil, OPEC struggling to increase production and unrest in Libya all supporting the market. With China potentially starting to ease lockdowns and with unrest in Libya still growing, the short-term price risk remains firmly skewed to higher prices.
During the past few weeks, the focus has turned from a rangebound crude oil market to the product market where the cost of gasoline, diesel and jet fuel have surged to levels not seen in years (if ever). The combination of refinery maintenance, a post pandemic reduction in capacity as well as self-sanctioning of Russian products have all led to incredible tight markets. Especially in North American refineries, where they are running flat out to produce what they can and, in turn, benefitting from mouthwatering margins.
So, despite the prospect for slower global economic growth, the price of crude oil remains supported. If we stick to our wide $90 to $120 range call for Brent during the current quarter, while still considering structural issues (most importantly the continued level of underinvestment and OPEC’s struggle to increase production), this will continue to support prices over the coming quarters.
US natural gas had another rollercoaster week, ending up off the highs after twice finding resistance around $8.5/therm. The current price is up by 200% compared to the same time last year, with record exports via LNG, flat production growth and a recent heatwave across the southern states increasing demand for cooling. However, the weekly injection of 89 billion cubic feet (bcf) to 1732 bcf was in line with expectations and helped reduce the deficit to the 5-year average to 15.2%. In addition, the milder weather ahead and Europe suffering from a temporary bout of LNG indigestion could suggest a period of stable prices. However, overall rising global demand and a sharp discount to prices in Europe and Asia is likely to prevent any significant weakness during the coming months.
What happened to the future?
What happened to the future?
Mitigate risks by emphasizing high-quality sovereign bonds and exploring potential opportunities in corporate bonds.
Uncover the shifting focus in 2024's FX markets towards growth resilience and relativity, away from bond yields and inflation stories.
Embrace the metal revolution on the commodity market in the coming year, with a focus on gold, silver, platinum, copper, and aluminum.
The gloominess of geopolitical conflicts and the repetitive nature of political agendas. What else does 2024 hold in store for us?
The disheartening cycle of unresolved geopolitical conflicts, the rise of polarizing political parties, and the stagnation of productivity.
Understand China's political landscape in Q4 2023 and the impact on counter-cyclical initiatives, with a focus on the pivotal Q1 2024.