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Commodity Weekly: Is the commodity rally over? Commodity Weekly: Is the commodity rally over? Commodity Weekly: Is the commodity rally over?

Commodity Weekly: Is the commodity rally over?

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector remains under pressure from a rising risk of recession, a stronger dollar, the US debt ceiling standoff and doubts about the short-term direction of US rates, and growing evidence the Chinese economic recovery is sputtering. Recent developments have raised an important question among traders and investors: whether the commodity super cycle is ending before it even started. While we maintain our positive long-term outlook for commodities, it has also become very apparent that we need answers to several key questions before seeing a fresh push higher, the most important being the direction of Chinese demand and the potential depth of a recession across key economies. Until then physical traders will be focusing on reducing inventories while hedge funds and other large speculators will continue to trade commodities from a defensive stance


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The commodity sector remains under pressure from a rising risk of recession, a stronger dollar, the US debt ceiling standoff and doubts about the short-term direction of US rates, and growing evidence the Chinese economic recovery is sputtering. Indeed, the increasingly pessimistic outlook on China has seen losses this month being led by industrial metals, currently down around 7%, while the energy sector is showing signs of stabilizing, with refinery margins having started to recover. Precious metals, led by weakness in silver, are heading for their first monthly decline in three months as the dollar and yields rise and the timing of future US rate cuts is priced further into the future.

Recent developments have raised an important question among traders and investors: whether the commodity super cycle is ending before it even started. As part of our weekly “Listeners’ podcast” series, the Saxo Market Call team asked our listeners where they saw the price of key commodities – such as gold, copper, crude oil and wheat – by yearend and, while expectations for gold hitting a fresh record high attracted 40% of the responses, the second highest at 31% was “None of the above: commodities are heading lower”.

Source: Saxo Market Call survey question via SurveyMonkey

While we maintain our positive long-term outlook for commodities, it has also become very apparent that we need answers to several key questions before seeing a fresh push higher. Goldman Sachs, in a recent note, wrote that the current weakness has been triggered by the largest destocking of physical stockpiles and financial positions in many years – driven by recession concerns and higher interest rates making it costlier to finance and hold positions, both physical and financial. However, unless a recession materialises, the commodity complex could see a strong rebound as speculators in financial commodities are forced back on the long side following a period of heavy net selling.

According to weekly reports from the US CFTC and ICE Exchange Europe, the net-long position held by hedge funds and other reportables in major metals and energy futures contracts has slumped to a more than seven-year low, namely driven by recent heavy selling in crude oil, diesel and copper.

Source: Saxo

Our reasons for maintaining a positive long-term outlook for commodities is as much a story about tight supply than strong demand. The main drivers we focus on are:

  • The green transformation supporting demand for industrial metals towards “new” energy.
  • Tight supply of key commodities due to rising input prices, lower ore grades (mining), rising regulatory costs and government intervention, climate change and lower investment appetite driven by ESG, investor and lending restrictions.
  • Structural inflation of 3-4% driving demand for tangible assets.
  • A weaker dollar.

Overall, the Bloomberg Commodity Total Return index – which tracks the performance of 24 major commodity futures contracts, spread evenly between energy, metals and agriculture – trades down around 4% on the month and 10% on the year with silver, copper and crude oil being the biggest losers while cocoa, gasoline, corn and cotton are the only contracts showing positive returns. EU natural gas, meanwhile, has slumped by more than 36% this month and currently trades near €24/MWh ($7.6/MMBtu) – a far cry from the near €90/MWh ($28/MMBtu) seen this time last year when the gas crisis was escalating as Russia cut supplies.

Source: Saxo

Negative EU gas prices this autumn?

Following extreme prices above €350/MWh ($110/MMBtu) last August, the European market is turning its attention to the risk of brief periods of negative day-to-day gas prices this autumn if sluggish demand continues to see prices crash while inventories are filling up fast. Countries with limited storage such as the UK have a higher chance of briefly seeing short-term natural gas prices dip below zero. Total inventory levels across Europe are currently near 67% full and if the current sluggish demand and brisk pace of injections via pipelines and LNG arrivals continue, we may see storage facilities top out by September or October. Depending on how soon winter demand kicks in, prices may even dip below €10/MWh in some extreme circumstances.

Copper slump ignoring long-term tailwinds

Copper prices slumped, with LME Copper falling below $8000 a tonnes for the first time since November, before bouncing as support was found ahead of $7800. The high-grade futures contract traded in New York reached support at $3.54/lb before finding a fresh bid in response to better-than-expected US data. The price is down around 15% from the mid-January peak at $4.35 when traders were busy positioning themselves for an expected strong reopening demand from China.

Instead, industrial metals, including iron ore, remain under pressure following a string of disappointing economic data from China, the world’s top consumer. In addition, the US debt ceiling standoff, recession fears and a recent recovery in the dollar have all become major headwinds driving prices lower, during a month that is typically known to be weaker for industrial metals demand.

These developments have all reduced the focus on an overall structural long-term story of support, 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.

High Grade Copper has slumped back to a November low, but so far support is holding at $3.54 ahead of $3.50, a 50% retracement of the 2020 to 2022 rally. Hedge funds have continued to sell for the past five weeks, and during this time the net position has swung from a 20k lots long to potentially the biggest net short since the depths of the Covid crisis in March 2020. At this point, a break back above an area of resistance around $3.80 to $3.82 is the minimum requirement for a change in sentiment to take hold.

Source: Saxo

These concerns were discussed at a 121 Mining Investment event in Melbourne, as concerns grow that the world will not be able to produce enough copper, lithium, aluminium, and other metals vital for electrifying the world. In an update from the event, Reuters wrote that most speakers made the same point: there is not enough production to meet anticipated demand, there are not enough projects in the pipeline, and even when new mineral deposits are discovered, the regulatory and financial barriers to developing them take years to navigate.

Overall, however, with multiple uncertainties from recession risks, the direction of the US short-term rates, the dollar and not least developments in China, our expectations for higher industrial metal prices will likely not materialise until answers are found to some of these questions, potentially not until later this year or early next year.

Gold remains challenged in the short-term as peak rates are delayed. 

Gold was heading for its biggest weekly drop in almost four months after recent weakness extended below $1950 following reports that the US economy continues to show resilience and while inflation shows signs of becoming sticky at a level too high for the FOMC to ignore – thereby raising the risk of further rate hikes and with that a postponement of a gold supportive peak rate situation. An upward revision to US Q1 GDP, lower-than-expected jobless data together with a pick up in inflation and consumer spending saw traders increase bets on a July rate hike while the prospect for rate cuts this year continued to evaporate. Support is currently found at $1933, while a break back above $2000 will be needed to improve sentiment.  

Crude oil rangebound ahead of June OPEC+ meeting

Crude oil prices trade rangebound and considering the recent news flow which, on balance, has been mostly price negative, it may indicate the month-long sell-off has run its course with consolidation the focus ahead of a bounce back later.

News flow has primarily centred on recent dollar strength, as the hike or no hike debate attracts increased attention. In addition, the US debt debacle, recession risks and a weaker than expected Chinese recovery have also played their part. However, with traders already holding the weakest exposure for more than ten years in the five major crude oil and product futures, one may argue that these potential headwinds are now close to being fully priced in. In addition we are seeing refinery margins, led by gasoline, starting to pick up following the April slump, a development that bodes well for crude oil demand going forward.

In the week to May 16, the combined gross short in WTI and Brent, held by money managers and other reportables, reached a near two-year high at 233 million barrels – marking a 111 million barrel increase in the last five weeks and 40 million barrels higher than the gross short that was registered ahead of the April 2 production cut. The return of short-sellers has once again left the market exposed to upside moves on any sudden change in the news flow – such as the response from Saudi Arabia’s Energy Minister Prince Abdulaziz bin Salman whom, when asked about the involvement of financial-commodity traders, once again said the they should “watch out”.

His comments highlight growing unease about the weakness seen during the past month, some of which has been driven by the return of these short sellers. His comments helped lift prices before a sudden turnaround after Russia’s Deputy Prime Minister Novak said OPEC+ was likely to stick to current production targets at their June meeting. Overall, the crude oil market is likely to remain rangebound with sharply lower prices unlikely to go unnoticed by OPEC while the upside potential can only be achieved once the economic outlook becomes clearer. In Brent, $80 remains the big level to break before talking about a change in direction.  

Corn futures pop on dry US soil conditions 

Corn futures in Chicago are on track for their biggest weekly rally in almost a year as dry weather threatens emerging crops in the US, the world’s biggest producer. Cool and dry weather favours planting of the remaining corn and soybean acreage, but lack of topsoil moisture is becoming more apparent. The July front month contract trades up 7.3% this week to $5.95/bushel, with short covering from hedge funds, who often concentrate their activity at the front and most liquid part of the futures curve, and providing some additional positive momentum. As a result, the December contract, which represents the crop that is being planted this spring for harvest in the fall, ‘only’ trades up 5% on the week.  

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