Head of Commodity Strategy
Summary: Commodities, most of which depends on demand from China, have been caught in the crosshairs of coronavirus developments. We take a closer look at the impact on key commodities from crude oil and copper to gold and soybeans.
While the coronavirus continues to the spread both in and outside China the market is trying to adjust positions across all asset classes. Since October investors have poured billions of dollars into the stock market and other riskier assets in the belief that the U.S.-China trade deal and ample central bank liquidity would support a period of rising asset prices and low volatility.
Another China-born virus put an abrupt end to this outlook with traders and investors having worked overtime this past week to limit exposure. Stocks, especially those in emerging markets have sold off while secure government bonds, led by U.S. treasuries, and safe haven currencies such as the Japanese yen have both received a bid.
Commodities, most of which depends on global growth and demand, have been caught in the crosshairs of these developments. Not least considering China being the world’s biggest buyer of most commodities from crude oil and fuel to copper and iron ore. Since January 20 when the Chinese Premier Xi Jinping finally issued his official instructions on dealing with the outbreak the Bloomberg Commodity Index has fallen by 4.7% while the energy heavy S&P GSCI is down by 6.7%.
Brent crude oil’s six-day drop from $66/b to $58.5/b yesterday was probably accelerated by hedge funds cutting bullish bets. Since early December when OPEC+ extended and deepened production cuts and up until January 21 hedge funds had bought close to 100 million barrels of Brent crude oil. They were left completely unprepared by the sudden change in focus from potential disruptions in Libya and the Middle East to the coronavirus impact on demand for fuel.
Having reduced exposure and after finding support ahead of the October low a $56.50/b we may now have seen the worst part of this adjustment phase. S&P Global Platts Analytics is forecasting a drop of 200,000 b/d in oil demand for the next two to three months. If however the coronavirus is as bad as the SARS outbreak in 2003, they see oil demand falling by 700,000-800,000 b/d, reflecting more than half of the expected demand growth for 2020.
Should the market manage to stabilize over the coming days some attention may return to Libya where the nation’s output could be days from grinding to a complete halt. This according to the head of the National Oil Corp and it comes in response to an escalating crisis which has cut oil production and closed export terminals.
OPEC, increasingly frustrated by the latest slump, stands ready to support the price through extending and potentially making even deeper cuts. For now the market will remain nervous about any further escalation in China and beyond. From a technical perspective support as per the chart below is $58/b followed by the October low at $56.15. In order to attract renewed demand it first need to reclaim $60.50/b.
Gold’s safe-haven credentials received another boost this past week when the virus threat sent the price higher to $1588/oz. However despite overwhelming support from developments across other markets it failed to challenge the January 8 high at $1611/oz. It highlights the extend to which the action so far this week has been all about cutting exposure. With investors already holding an elevated long position through futures and ETF’s the need to reduce across markets exposure probably led to this slightly disappointing development.
Overall this past week we have seen gold being supported by U.S. 10-year real yields falling to negative 0.05%, rising expectations for a U.S. rate cut, total global negative yielding debt jumping by $2.3 trillion and the biggest two-day sell-off in U.S stocks since last October. Against this the dollar has with the exception against JPY and CHF been strengthening thereby creating some headwind.
Gold’s lack of reaction to an overwhelming bullish environment has left a few nervous longs looking for the exit. While we maintain a long-term bullish outlook for different reasons than the current in 2020 the market may once again be exposed to a small correction. Especially if the U.S. stocks, led by decent earnings from the technology companies this week continue to recover. Support below at $1560/oz followed by $1535/oz.
HG copper’s near 10% plunge during the past week highlights not only the impact China has on demand for industrial metals, but also its role as one of hedge funds’ favorite macro plays on China developments. The eight-day plunge from close to $2.9/lb back below $2.6/lb is one of the longest ever for the white metal and it has been driven by short-selling interest from funds looking for a hedge against the potential economic fallout from the coronavirus in China and abroad. Any further weakness could see copper move close to the 2018-19 area of support below $2.55/lb.
China’s ability to deliver on its phase one trade deal commitment to buy energy and agriculture products has also been called into doubt. As a result the price of soybeans has slumped back to levels seen before the trade deal was agreed. Coffee meanwhile has suffered due to an extended long not receiving any support from a weaker BRL and a rising contango which provides short-sellers with a premium at each futures roll.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
