Head of Commodity Strategy
Summary: The commodities sector is heading for its worst weekly drop since March following a week that saw broad selling across all sectors except softs. The energy sector once again attracted most of the attention with wrong-footed long positions heading for the exit as the market focus increasingly turned from tight supply and geopolitical risks to softer demand following a week that saw manufacturers in the United States, Europe and China all report worse business conditions in October. While gold shows signs of stabilizing other metals like silver, platinum and palladium remains under pressure from weaker industrial demand.
Elsewhere, the metal sector traded mixed with the recent gold correction showing signs of running out of steam while silver, platinum and not least palladium, three metals depending on industrial demand, took a tumble as the economic clouds darkened. Finally, the grains sector traded lower after the US Department of Agriculture surprised traders after forecasting a record US corn production and elevated global stocks of soybeans and wheat following a production season that turned out much better than originally feared.
On the macroeconomic front, the US dollar rose against most of its peers, led by AUD, JPY and GBP weakness while US bond yields rose after Federal Reserve chair Jerome Powell said the US central bank will continue to move carefully but won’t hesitate to tighten policy further if needed to contain inflation. His comments at the IMF conference struck a hawkish tone as he attempted to dial back the dovish repricing seen following the FOMC meeting and NFP miss last week, which led to a 44 basis point slump in US 10-year yields below 4.5%, and a 25 basis point drop in the yield on policy-sensitive two-year notes, while supporting the best period for S&P 500 since 2021. Easing financial conditions at a time when inflation is not yet back to the desired level could not be tolerated, and while we believe the Fed is done hiking rates, the FOMC members will have to avoid sending such a message until it is absolutely necessary, in order to avoid markets running ahead of themselves.
The Bloomberg Commodity index which tracks 24 major commodity futures spread almost evenly across energy, metals and agricultural sectors, was heading for a weekly loss of 3%, its worst since March led by a 7% drop in energy and 2.4% in precious metals. The agriculture sector continues to see a growing divide between an ample supplied grains sector following a robust northern hemisphere production season and a softs sector which is seeing a tightening supply of coffee, cocoa and sugar as El Niño-related weather developments continue to impact key production regions on the Southern hemisphere. As a result, the softs sector trades up by more than 30% year-to-date while the grains sector has lost more than 10%, the latter bringing some relief to consumers around the world.
Despite the current price softness, driven by economic growth concerns in China, Europe and potentially also the US, Saxo holds the view that key commodities are at the beginning of a multi-year bull market driven by CapEx drought due to rising funding costs, lower investment appetite and lending restrictions. The green transformation is creating “greenflation” through rising demand for industrial metals towards “new” energy at a time when miners are faced with rising costs, lower ore grades, growing social and environmental scrutiny, and in some cases resource nationalism.
In addition, we are seeing increased fragmentation pushing up demand for, and prices of, key commodities. The agriculture sector will likely face a higher degree of weather volatility and price spikes. Overall, these supply and demand imbalances may take years to correct, ending up supporting structural inflation above 3% which will likely increase investment demand for tangible assets such as commodities.
Tight supply across several key commodities has, since late 2021, delivered a positive year-on-year gross roll yield return on the Bloomberg Commodity index. The gross roll yield shows the difference between the performance of spot and total return, the spot price being the prompt futures contract that strategists and technical analysts tend to follow while the total return index shows the actual realised return which includes funding costs, storage and not least the positive return from rolling futures contracts in a tight market (like now) called backwardation or negative return when rolling contracts in an ample supplied market called contango.
The average gross roll yield return during the past 10 years is -3.25% and highlights a long period of ample supply leading up to the 2020 pandemic-led period of disruptions and surging demand for consumer goods. During this time, roll yields spiked, leading to a 9.25% peak last December before drifting lower to the current 4.5%. We believe positive roll yields caused by this tightness will continue to underpin investment demand for the sector in the months and quarters to come.
Gold has been undergoing a period of consolidation since hitting a $2009 high last month. That short-term peak was reached following a near 200-dollar rally driven by wrong-footed technical-driven short sellers flipping positions back to longs, geopolitical risks associated with the Israel-Hamas war and not least concerns about the continued surge in US bond yields with traders and investors growing increasingly concerned about US fiscal policy – especially whether the recent jump in both real and nominal yields would end up ‘breaking something’.
These concerns faded following the dovish FOMC meeting on November 1, and with easing fears of contagion in the Middle East, this allowed traders to book some profits. In the process, this raised the risk of additional long liquidation from money managers such as hedge funds and CTA’s who in just three weeks bought the second biggest amount of gold futures on record.
Having corrected lower by around 60 dollars, but without seriously challenging key support levels, the first being around $1933, we believe the correction phase is running out of steam. Powell’s hawkish turnaround, as previously mentioned, was not that surprising given the need to keep financial conditions relatively tight for now, and it explains why gold traders ignored his comments. We maintain the view that the Fed is done hiking rates and that rate cuts from around the middle of next year, together with record demand from central banks, will continue to support a move towards a fresh record high next year.
Support on spot gold is currently around $1933, the 200-day moving average and 38.2% retracement of the rally. Given the length of the recent rally, gold can correct back below $1900 without damaging the bullish setup, while a fresh break above $2000 may give traders the confidence to push it higher towards the $2050 level.
In the short term, we will be watching silver and platinum, both of which have been struggling amid the lower growth outlook raising questions about the near-term outlook from industrial users, not least those in the green transformation industry as the rising cost of financing has been hurting the wind and solar sectors, and increasingly also the hydrogen sector, a future source of expected demand for platinum. Palladium is also worth watching having fallen to a five-year low amid speculative selling forcing producers to hedge at levels that increasingly are through the aggregate cost curve. A 14k lots futures gross short position is close to 4X daily traded volumes, leaving the metal exposed to a major squeeze once the technical and/or fundamental outlook improves.
The energy sector is heading for its worst weekly performance since March with losses being led by the notoriously volatile natural gas contract, down more than 10% on the week, driven by muted demand for heating as November stays warm and production nears an all-time high. Meanwhile, the sell-off in crude oil and fuel products accelerated this past week with Brent briefly falling below $80 for the first time since July while WTI was hurled below $75 before stabilising.
Prices have increasingly come under pressure as the market focus turned from tight supply supported by Saudi production cuts and a brief spike in the war premium following Hamas’ October 7 attack on Israel, and subsequent response from the Israeli Defence Force in Gaza. However, while the death toll in Gaza from Israeli counterattacks continues to rise to unimaginable levels, the prospect of the conflict spreading to the oil-rich part of the Middle East has increasingly been put at near zero.
Instead, the market focus has turned to a weakening demand outlook as the economic outlook weakens in Europe, the US and not least China, the world’s top importer. The turnaround in the outlook and prices has been exacerbated by selling pressures from speculators who bought more than 325 million barrels in the futures market between early July and the end of September on the prospect of Saudi cuts lifting the price. During this time, the gross short slumped to a 12-year low leaving no positions left to absorb a correction like the one we have seen during the past couple of weeks, hence the risk of crude prices falling to low levels that are not justified by current fundamentals.
Brent Crude oil support at around $78.34 with no clear support below until around $72, the May to June lows. Medium-term Brent is in a downtrend that would be further confirmed by a weekly close below $81.94. Likewise a close above may signal a short-term upside to $84.78, the 0.382 retracement of the most recent sell-off from $93.80.
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