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Summary: The ongoing risk rally, abetted by central bank and government action, is the dominant factor in the commodities space.
Commodities started March on the defensive as losses across key agricultural products and emerging profit-taking in precious metals more than offset gains especially among industrial and platinum group metals. Continued investor appetite for global stocks was led by strong markets in Asia, not least in China.
Central bank and government action has in recent weeks provided market-supportive fiscal and monetary stimulus. These developments have supported a 28% surge in the CSI 300 index since the beginning of January. Adding to the bullish sentiment this week was confirmation from the MSCI that it will raise the weight of Chinese stocks in its global emerging markets index.
Strong US data helped send yields higher and the Japanese yen to a 10-week low at ¥112 to the dollar, thereby supporting the risk-on sentiment. US inflation expectations, meanwhile, continued to climb higher towards 2%, raising some early warning signs that the market’s dovish belief in no further US rate hikes may be challenged sooner rather than later.
So far, these developments (especially in China) have led to speculation about increased demand for industrial metals while easing fears about slowing demand growth for crude oil.
The agriculture sector remains the most challenged among the three major commodity sectors. Weakness was led by the grains sector with the Bloomberg Grains Index heading for a record low close. This comes after the May CBOT Wheat contract dropped hard in response to weak US export sales amid continued stiff competition from other producers and ahead of what is expected to be another bumper 2019 crop. Because of this weakness, the premium to corn hit a contract low of just 86 cents/bushel – well below the one-year average at 155 cents/bushel.
Precious metals suffered from the aforementioned risk appetite across other assets with gold seeing its biggest weekly decline since November. A combination of continued demand for stocks, a stronger dollar, rising US bond yields and the recent rejection at $1,350/oz all helped attract profit-taking.
After reaching a six-year high on January 31, total holdings in bullion-backed ETFs have since seen a continued decline throughout February.
While gold’s six-month rally showed signs of pausing, platinum has picked up the baton to emerge from gold’s shadow. The combination of the continued rally in palladium and a record discount to gold has helped attract renewed (speculative) demand. During the past two weeks, the discount to gold has collapsed by more than $80 to $440/oz. The white metal is not facing the same amount of strong resistance that has helped trigger profit-taking in gold.
Gold has gone looking for support after breaking the uptrend from November. The first level of support at $1,300/oz is followed by the more important $1,275/oz – a level that represents the January consolidation low and the 38.2% retracement of the August to February rally.
High-grade copper was a star performer during February on the back of tightening supply and optimism on several Chinese fronts. However, with a positive outcome of the US-China talks almost fully priced in and the dollar grinding higher we see the risk of a short-term pullback to test support.
Supporting the rally has been a recent decline in copper stocks held at London Metal Exchange-monitored warehouses to the lowest since 2005. While this has created a sense of tight supply, we have simultaneously seen a strong increase in deliverable stocks at the Shanghai Futures Exchange.
HG Copper is showing signs of consoldation and with that the risk of a short-term reversal towards the highlighted area below $2.8650/lb.
Crude oil experienced a roller-coaster week at the hands of another Trump tweet and continued supply cuts from the Opec+ group of producers. The recent rally in WTI and Brent crude oil towards $60/b and $70/b respectively once again caught the attention of President Trump. In a tweet last Monday, he once again went after Opec and asked the cartel to “take it easy” on production cuts, saying that the world is too “fragile” to handle price hikes at this stage.
Following the initial sell-off, the market quickly recovered after comments from the Saudi Minister of Energy saying that the current production cut deal could be extended into the second half of the year. The minister is playing it safe with this comment to make sure that the market refrains from selling oil in response to rising US shale production and before the price-supportive tightness becomes visible in the data.
In addition, Russia’s Energy Minister Alexander Novak was out saying that Russia has cut output by close to 150,000 barrels/day and that it will reach its 228,000 b/d target by early April.
The extent to which Opec has cut production in recent months was seen in the monthly production survey carried out by Bloomberg. In February production from its members slumped by 560,000 barrels/day to 30.5 million barrels/day, a near four-year low.
Speculators increased bullish Brent crude oil bets by 10.7k lots to 275k lots in the week to February 19. Seven weeks of buying, however, began to show signs of fading with fresh short-selling emerging last week despite the technical break above $64/b witnessed during the week in question.
On the back of this observation and a continued drop in open interest on the Brent futures contract since February 15, we suspect macro funds have started to fade (sell into) the current rally in the belief that economic headwinds may offset the positive impact of production cuts.
Macroeconomic uncertainties still exist but the drumbeat of worsening economic data has so far been difficult to hear amid all the hype about the potential positive impact of a trade deal. We suspect that most of the positive impact of a deal has been priced in, particularly considering that global stocks have returned to their pre-trade war levels – an unsustainable height given the raised recession risk currently emerging across the world.
Despite supportive fundamentals, as supply tightens we see the short-term risk of a deeper correction than the one seen post- the Trump tweet. Just like gold has broken its uptrend, the same could happen to Brent crude on a break below $65.30/b. This would potentially create a period of consolidation with support at $64/b and ultimately $60/b being tested.
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