Head of Commodity Strategy
Summary: The commodity sector started August in consolidatory mode and after two months of broad gains, all sectors apart from energy have seen weaker price action so far. The energy sector trades up 16% on the quarter, supported by a tight supply outlook for crude as OPEC+ curbs production while demand is scaling record highs. The weakness seen so far this month has been led by the metal sector with industrial metals struggling after a string of weak economic data highlighted the current challenges China, the world’s top consumer of metals, continues to face
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The commodity sector started August in consolidatory mode and after two months of broad gains, all sectors apart from energy have seen weaker price action so far. Overall, the Bloomberg Commodity Index, which tracks a basket of 24 major commodity futures, trades down 1.3% on the month and 3.3% on the year. The energy sector which includes crude oil, fuel products and natural gas trades up 3.8% on the month and 16% on the quarter, supported by a tight supply outlook for crude as OPEC+ curbs production while demand is scaling record highs, boosted by strong summer air travel activity and increased demand for power generation amid a global heatwave. Even natural gas prices have picked up to meet increased demand for power amid the aforementioned heatwave which has seen temperatures across the US exceed seasonal averages.
Commodity weakness seen so far this month has been led by the metal sector with industrial metals struggling after a string of weak economic data which highlighted the current challenges China, the world’s top consumer of metals, continues to face. Precious metals meanwhile have been dragged lower by rising bonds yields and a firmer dollar, and asset managers cutting exposure amid rising funding costs. The grain sector also traded lower after the early July surge deflated following improved growing conditions across the Northern Hemisphere helped lower but did not remove continued concerns about food exports from the Black Sea region.
The energy sector, including natural gas, has risen strongly this quarter with sentiment experiencing a major positive turnaround as aggressive voluntary production cuts from Saudi Arabia continue to tighten the market. In addition, concerns about the global economic outlook have yet to impact demand which, according to the IEA, hit a record and could move even higher in August, potentially prolonging the current rally until OPEC decides to increase production by tapping into the an estimated 5.7 million barrels a day of spare capacity.
These developments have seen WTI and Brent reach four-month highs, and just like last year, when prices shot higher following the Russian invasion of Ukraine, the rally has been led by tight diesel markets which have sent prices for gas oil futures in London and Ultra-light Sulphur Diesel (ULSD) in New York surging to $123 and $131 dollars respectively per barrel, the highest levels since January. In WTI crude oil, the premium the prompt futures contract, currently CLU3, commands over the next month reached a November high and the tightness or backwardation of this magnitude highlights the current bullish sentiment.
According to IEA’s latest Oil Market Report, global fuel demand averaged 103 million barrels a day for the first time in June and may soar even higher in August. With Saudi Arabia and its OPEC+ partners keeping supply constricted, the market looks set to tighten further, resulting in a 1.8 million barrels a day deficit during the second half.
Crude oil production from the OPEC+ group of producers fell to a two-year low in July according to the latest Platts OPEC+ Survey carried out by S&P Global Commodity Insights. While OPEC pumped 27.34 million barrels/day, non-OPEC allies produced 13.1 million barrels/day, with the bulk of the reduction being driven by Saudi Arabia’s aggressive voluntary production cut which has so far been extended to include September. The one million barrel a day cut has seen the Kingdom’s production slump to a two-year low and some two million barrels below what it pumped last September.
At the beginning of June managed money accounts held a 231 million barrel combined net long in Brent and WTI, and apart from the March 2020 Covid-19 outbreak slump, this was the lowest confidence in higher prices since 2014. However, following the Saudi cut and the energy ministers' vocal threat to hurt speculators, a six-week buying spree unfolded and according to the latest Commitment of Traders Report covering the week to August 1st, it helped lift the combined net long by 82% to 421 million barrels. Looking into the numbers we find the bulk of the buying (61%) has been short covering, and despite having seen prices rally by more than 15%, it highlights a hesitancy about getting extended on the long side, especially when the bulk of the tightness has been driven by a politically motivated production cut. With this in mind, we keep our Q3 outlook that sees limited risk of a sustained move above $90.
In Brent, the key level of support can be found around the 200-day moving average, currently at $81.54, while some resistance has emerged ahead of the January high at $89.
During the past couple of months gold prices have settled into a $1900 to $1980 range with the market struggling for direction amid uncertainty surrounding the timing of peak rates in the US. The yellow metal traded near a one-month low on Thursday, despite the latest CPI print reiterating the current disinflationary theme, after Fed’s Daly said the Fed despite the easing inflation had “more work to do”, not least considering the latest spike in energy prices which could make the August print look even uglier.
Looking at correlations to other markets, the biggest input currently is coming from movements in the dollar, and the greenback has seen broad strength this past week supported by higher bond yields adding downside pressure to the Japanese yen while other Asian currencies have struggled amid the aforementioned weakness in Chinese economic data. Apart from dollar strength hurting sentiment, we continue to see asset managers and long-term investors reducing their exposure to gold through ETFs. Since the May peak that followed the March banking crisis, total holdings in ETFs have slumped by 109 tons to 2821 tons and the lowest since January 2000.
Part of the reduction has been driven by headwinds triggered by the cost of carry or opportunity cost in holding gold relative to the interest received on a short-term government bond. Recently the futures roll between the expiring August contract and December, meant that the new front month contract attracted some attention given the 34-dollar premium that the December contract traded above the August contract. The bulk of the difference reflects the current level of interest rates. The below chart shows the percentage spread between spot gold and the one year forward gold price. It’s clear that the bulk of the increase from next to nothing back in 2021 to the current 5.8% has been driven by the rising funding cost of holding a position in gold.
While we maintain a bullish outlook for gold, these developments also highlight the risk gold may continue to struggle attracting demand from investors until rates peak and begin to turn lower. For now, traders will primarily focus on whether gold can maintain support around $1900, the 200-day moving average, or whether a break may trigger an extension towards $1865.
Natural gas in the US and Europe has joined the rally in crude and fuel prices with gains of 8% and 28% so far this month. While hot weather in the US has raised demand for power towards cooling, thereby slowing the stock building pace ahead of winter, it is supply concerns that have seen gas prices in Europe surge higher. On Wednesday the price jumped 40% to temporarily trade above €40/MWh ($13/MMBtu).
The trigger driving aggressive short covering was concerns about potential strike action at three major LNG export facilities in Australia, potentially impacting 10% of global LNG shipments and in the process cause increased competition from Asian buyers for gas otherwise destined for Europe, a region that has become more dependent on LNG imports following a steep drop in supplies from Russia. The latest spike highlights the risk of another volatile winter given the uncertainty about weather and production from renewables. For now, the price jump has not impacted the cost of winter supply with the October to March winter futures contract staying anchored around €50/MWh ($16/MMBtu).
An ongoing heatwave across the world continues to create a challenging situation for farmers producing key crops from sugar and rice to oranges and cocoa, and in some cases, it is now leading to export curbs, most recently in India, a major supplier of rice and sugar. While climate change is being blamed, it is also worth noting the simultaneous coming together of two extremes, namely a returning El Niño and last year’s massive underwater earthquake in the South Pacific Ocean which blasted an enormous plume of water vapor into the Earth’s stratosphere, enough to temporarily affect Earth’s global average temperature.
While there are reasons to believe, or hope, some of the current weather events could be temporary and fade in a year or two, the short-term outlook remains challenging. This past week the price of Thai white rice, the regional benchmark, surged to $648/ton, a 48% year-on-year increase and highest level since 2008. The grain, a vital diet to billions in Asia and Africa, has been underpinned by a combination of lower production in Thailand, the world’s second biggest shipper and most recently after India, which accounts for 40% of the world’s trade, stepped up export curbs to protect its local market from shortages and price spikes.
So far, UN FAO’s Global Food Price Index, which tracks a basket of more than 90 food commodities, has been showing steady monthly declines since the March 2022 record peak when the Russian invasion of Ukraine raised concerns about the supply of key crops. However, a 23% decline since that peak is showing signs of reversing after the index rose 1.3% in July. On a year on year rolling basis, only the sugar basket trades up (+30%) with the biggest laggards being vegetable oils (-20%) and dairy (-19%). The grain basket, which includes wheat and not least rice, is currently down 14.5% year-on-year and is currently being held down by weakness in soy and corn products.
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