WCU: Growth worries slow tight supply-led commodity surge
Head of Commodity Strategy
Summary: Commodities traded mixed with some weakness and profit taking emerging after US inflation surged to 7.5%, its fastest annual rise in 40 years. The nervous response to the high inflation print was driven by concerns an aggressive rate hike cycle would hurt economic growth and with that demand by more than previously expected. For now, however, the commodity market’s main concern remains the outlook for tight conditions supporting prices across all sectors from crude oil and fuel to aluminum and copper, as well as some key crops and coffee.
Commodities traded mixed with some weakness and profit taking emerging after US inflation surged to 7.5%, its fastest annual rise in 40 years. The nervous response to the high inflation print, which sent treasury yields sharply higher while also reinjected renewed uncertainty in the stock market, was driven by concerns an aggressive rate hike cycle would hurt economic growth more than previously expected. For now, however, the commodity market’s main concern remains the outlook for tight conditions supporting prices across all sectors from crude oil and fuel to aluminum and copper, as well as key crops and coffee.
Weakness across the energy sector led by a mild weather slump in natural gas as well as the first weekly drop in crude oil since December, on the prospect for a revival of the Iran nuclear deal, helped send the Bloomberg Commodity Spot Index towards its first, albeit small, weekly loss in two months. The LME Industrial metals index reached a fresh record on broad supply tightness led by aluminum and copper before suffering an end-of-week setback in response to the US CPI print and its potential negative impact on growth with a succession of rate hikes priced in over the coming months.
Industrial metals, led by aluminum and copper, and the grains sector led by soybeans all surged higher before being disrupted by Thursday’s eyepopping US inflation print as it may dampen the outlook for demand. Aluminum hit a 13-year high with the most energy intensive metal to produce suffering supply cuts at a time when Chinese monetary easing and infrastructure spending pledges has supported demand. Copper, which has traded within the same range for the past ten months, made another breakout attempt only to be slapped down as the CPI print hit the screens.
Soybeans and corn traded higher but off their highs as weather worries in South America continue to support a tight supply outlook. Soybean's premium over corn reached the highest level since 2014 and with the US planting season approaching these developments could see farmers favor soybeans over corn, thereby inadvertently supporting the price of corn due to the risk of lower acreage leading to lower production during the coming season. Weather worries in Brazil supported a renewed rally in Arabica coffee with the futures price in New York reaching a fresh 11-year high. The latest move in response to a continued drop in ICE exchange monitored stocks to 1.03 million bags, the lowest level in 22 years.
As mentioned, US January CPI rose to the highest in 40 years, and the numbers jolted Fed expectations sharply higher for coming meetings and saw risk sentiment rolling over as the Fed is seen as needing to chase this development and show some credibility. With seven rate hikes now priced in over the coming 12 months, the latest inflation print suggest that the Fed remains so badly behind the curve that it must move aggressively to catch up with the inflation debacle that is unfolding and regain some credibility. Given that we are more than a month away from the next FOMC meeting on March 16th, some argue that the Fed may have to make a move ahead of the meeting – the first inter-meeting move for the purpose of tightening policy in modern memory.
With supply of many key commodities being as tight as they are, the prospect for higher prices remains but a flattening yield curve in US is being taken as a warning sign that the US economy, and several others that has been on a sugar high following the pandemic, are at risk of seeing an economic slowdown as central banks apply the brakes.
Into this period of uncertainty, we see continued demand for gold which despite an extended sell-off in US treasury bonds has managed to hold onto a second weekly gain. This week, ten-year yields punched past 2% with real yields rising to a fresh cycle high at -0.43%, up nearly 0.7% since the start of the year. However, the mentioned flattening of the yield curve suggests investors expect slowing growth into the oncoming rate hike cycle.
In our latest gold update we highlighted gold’s ability to defy gravity amid rising US yields and how any weakness below $1800 has so far proven to be short-lived. Support driven by gold’s credentials as an inflation hedge as well as a defensive asset during a period of elevated stock and bond market volatility as the market adjusts to a rising interest rate environment. At the same time, we believe inflation will remain elevated with rising input costs, wages and rentals being a few components that may not be lowered by rising interest rates. With this in mind, gold is increasingly being viewed as a hedge against the market’s current optimistic view that central banks will be successful in bringing down inflation.
While asset managers have shown renewed interest through the accumulation of longs in ETFs backed by bullion, the price action has yet to trigger any increased interest from momentum focused leveraged money managers who tends to buy into strength and sell into weakness. For this segment to get involved, gold as a minimum needs to break above the 50% retracement of the 2020 to 2021 correction at $1876 which is also the 2021 high. In the other direction, failure to hold above $1780 and more importantly $1750 may signal a deeper correction.
Crude oil was heading for its first weekly drop in eight with the focus being the prospect for a deal with Iran paving the way for additional production and exports. An injection of extra barrels that, according to IEA’s latest Oil Market Report, is sorely missed because of the OPEC+ groups “chronic” struggle to revive production. Plagued by under-investment and disruptions, output from the 23-nation OPEC+ alliance missed the agreed production targets by 900,000 barrels per day in January, and the IEA could see this situation continue to worsen, thereby exacerbating the current market tightness. In addition, the IEA said that the punitively-high gas prices in Europe during the final quarter of 2021 had added 250-300,000 barrels per day to Europe’s oil demand.
With Saudi Arabia being one of the few producers with a meaningful amount of spare capacity not showing any willingness to add additional supplies, the market has increasingly turned its attention to Iran and renewed efforts to revive the nuclear accord. An agreement could according to the IEA add 1.3 million barrels per day, an amount that would go a long way to stabilise the market before rising non-OPEC production, led by the US will help tip world oil
Global oil demand, however, is not expected to peak anytime soon and that will add further pressure to available spare capacity, which is already being reduced monthly, thereby raising the risk of even higher prices. This supports our long-term bullish view on the oil market as it will be facing years of under investment with oil majors diverging some of their already-reduced capital expenditures towards low-carbon energy production.
However, in the short-term, Brent crude oil, in a steep uptrend since early December, looks increasingly in need of consolidation, and in case of further economic growth worries and not least a Iran deal the price could drop to $83 or even $80 without changing the long-term bullish prospect. For now, the price has settled into a four-dollar range between $90 and $94.
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