Head of Commodity Strategy
Summary: The turmoil seen across the commodity sector since Russia invaded Ukraine has yet to show any signs of easing. Volatility remains very elevated, not least across the energy sector with the result being reduced positioning and more erratic trading behavior with conviction levels at a very low level. Adding to the current state of uncertainty the market will be focusing on the US administration for signs of an accelerated SPR release and today's OPEC+ meeting which in advance has been written off as another non-event.
The turmoil seen across the commodity sector since Russia invaded Ukraine has yet to show any signs of easing. Volatility remains very elevated, not least across the energy sector which has reached levels last seen during the pandemic panic in early 2020. The result being reduced positioning and more erratic trading behavior with conviction levels at a very low level.
While the main driver remains lack of Russian supplies due to self-sanctioning by traders, the market has also been trying to gauge the negative demand impact current covid outbreaks and lockdowns in China, a so far illusive Iran nuclear deal potentially adding barrels, the level of demand destruction from rising prices and developments in the US bond markets increasingly pointing to an economic slowdown into the second half of 2022 and beyond.
The result of all these being a market were traders lack conviction and where raised margin calls and a misfunctioning physical market has left normal trading/hedging strategies challenged. High volatility reduces trader conviction and their ability to hold onto a strategy, and the result has been a sharp reduction in the number of open positions held in key energy futures from crude oil and products to European gas. Excluding the latter the open interest across the five main oil and fuel futures contracts has slumped to a seven-year low.
Having spent the past five weeks within a 96 to 136-dollar range, raised but yet illusive hopes for a peace deal between Russia and Ukraine as well as the mentioning reduction in Chinese demand have all helped steer the price back down towards the lower part of that range.
Overnight the price dropped by an additional $5 per barrel in a matter of minutes with Brent touching $107 per barrel on news the Biden administration is considering a plan to release a million barrels of crude oil a day from Strategic Reserves for several months, to combat rising inflation and to offset losses from Russia. A release of this magnitude, potentially lasting for six months would go some way to minimize to risk of even higher prices, but it does not solve the long-term structural problem where lack of investments will make it difficult to increased production by the +5 million barrels a year that is needed to maintain global production at current levels.
In other oil related news, OPEC+ meets virtually today and without addressing slumping exports from Russia they are likely to rubberstamp an already agreed but increasingly impossible to achieve increase of 432k b/d, higher than the usual 400k due to fine tuning of individual nations production quotas.
In our soon to be published outlook for the third quarter we highlight the reasons why Brent is likely to trade within a 90 to 120-dollar range, now subject to an adjustment should the SPR released be announce, potentially as early as today. In the short-term, Brent weakness below the 21-day moving average for a third day signals loss of momentum with the next support being the $101.50 to $102 area.
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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.
