Head of Commodity Strategy
Summary: Cautious and defensive trading best describes the early 2023 price action across the commodity sector, and while the year ahead will hopefully provide less drama and voilatility than last year, plenty of unresolved issues ramain. The main questions being asked early on relates to China’s messy exit from its long-held Covid-zero policy and what the recovery will look like. Add to the mix inflation, recession risks and the sad and unresolved situation in Ukraine and we could see a weak first quarter being followed by strength in the following
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Today's Market Quick Take from the Saxo Strategy Team
Cautious and defensive trading best describes the early 2023 price action across the commodity sector. A year that hopefully will provide less drama and volatility than last year, which saw the Bloomberg Commodity Total Return index surging to a first quarter gain of 38% before spending the rest of the year drifting lower to record a second consecutive yearly gain of 11% – a respectable return considering the adverse impact of a stronger dollar and the steep losses seen across stocks and bonds.
Plenty of unresolved issues remain and it is the solution to these that will help determine what kind of year lies in ahead. The main questions being asked by commodity traders and investors relates to China’s messy exit from its long-held Covid-zero policy and what the recovery will look like. Elsewhere, central banks inflation fighting efforts and the extent to which they will force an economic slowdown, or perhaps even a recession, across several regions remain another major driver of volatility and uncertainty.
Meanwhile, inflation has peaked. This has been aided by lower commodity prices and, after hitting a multi-decade high in 2022, a key question in 2023 remains its ability to return all the way back towards 2.5% – a level currently being priced in as the medium and long-term target for US inflation. Finally, Russia’s attempt to stifle a sovereign nation and the western world's push back against Putin’s aggression remains a sad and unresolved situation that continues to cause havoc across global supply chains of key commodities from crude oil, fuel and gas to industrial metals and key crops.
Hedge funds showed a strong interest in commodities during the week to December 27 according to the Commitment of Traders report. In our latest update covering this group of traders or speculators, we found them to be net buyers of all but one of the 24 major commodity futures tracked in our report. This resulted in the combined net long rising by 16% to 1.4 million lots, a six-month high. Two-thirds of the increase was driven by fresh longs being added while the remaining third was driven by traders cutting back on short positions.
With all sectors aside from natural gas getting bought, the driver behind these developments must be found in overall macroeconomic developments, most notably the weaker dollar and emerging optimism about the demand outlook in China that prevailed ahead of year end. It also helps to explain some of the weakness seen this past week as traders scaled back recently established positions.
Traders' conviction at the beginning of a new trading year always tends to be low for fear of catching the wrong move. At the same time, however, the fear of missing out (FOMO) can also drive a rapid buildup in positioning which subsequently can be left exposed should a change in direction occur. In the short term, these mechanics will have an impact on the price action across markets, an example being the movements in both gold and crude oil this past week.
Gold jumped out of the gate to kick off 2023 with a strong gain as the positive momentum from December was carried over. However, having surged out of the box earlier in the week, gold bulls got an early reminder on Thursday that this is marathon and not a sprint. This, after a strong US ADP employment report, hurt risk sentiment across markets with yields and the dollar rising while gold took a dive. Inadvertently, the report also helped reduce the negative price impact of another strong US job report on Friday.
The overall bullish sentiment towards gold has not been changed by one report but it highlights the need to be patient while the FED remains in hiking mode and while the level of peak Fed rate remains unclear. In general, we are looking for a price friendly 2023 for investment metals supported by recession and stock market valuation risks, an eventual peak in central bank rates combined with the prospect of a weaker dollar and medium-term inflation not returning to the expected 2.5% level but instead settling around 4%.
In addition to the above-mentioned supportive drivers for gold this year, we see continued strong demand from central banks providing a soft floor in the market. During the first three quarters of last year, the World Gold Council reported official sector purchases of 673 tons, higher than any full year since 1967. Part of that demand is being driven by a handful of central banks wanting to reduce their dollar exposure. This de-dollarization and general appetite for gold should ensure another strong year of official sector gold buying.
Adding to this, we expect the friendlier investment environment for gold to reverse last year’s 120 tons reduction via ETFs to a potential increase of at least 200 tons. Hedge funds meanwhile turned net buyers in early November when a triple bottom signaled a change away from the then prevailing strategy of selling gold on any signs of strength. As a result, the net position during this time flipped from a 38k contract net short to a 67k contract net long on December 27.
In the short-term, gold may drop to $1808, the 21-day moving average, and still remain in the uptrend that started back in November. It will be its ability to hold that support on stronger than expected economic data which will give us a clearer indication about the underlying strength in the market from investors potentially looking beyond short-term developments.
US natural gas prices slumped to a one-year low at $3.55 on forecasts for milder January weather replacing the frigid cold spell that saw parts of the US grind to a halt ahead of the new year. With milder weather emerging, the much-watched March-April spread – used as an indication of how anxious the market is about the availability of gas in late winter – slumped to just 7 cents having touched $1 in early December.
The slump in Europe’s gas price meanwhile continued for much of the same reasons, and during the past month the price of Dutch TTF benchmark gas has slumped and reached €65/MWH ($20/MMBtu) at one point – the lowest since October 2021. The slump has been driven by a combination of mild weather and strong production from renewables as well as reduced industrial consumption resulting in an unusual seasonal increase in inventories. Gas held in storage across Europe is currently 168 TWh above the five-year average and close to a full month of peak winter withdrawals.
With LNG imports still strong and demand down by more than 10% the continent has now ended up in a situation, unthinkable just a couple of few months ago, where prices need to stay low in order to divert LNG shipments away from Europe in order not to overwhelm local storage facilities.
Copper and iron ore managed to post small gains during an otherwise challenging week, where China’s messy exit from its long held covid-zero strategy has led to a surge in virus cases across the country. While the short-term demand outlook is challenged the change, as opposed to continued lockdowns, has brought forward to timing of a recovery in China – the world’s top consumer of commodities. However, with the Lunar New Year holiday starting already on January 23 this year, the prospect for a pickup is unlikely until after, perhaps not until well into spring.
HG copper survived a mid-week selling attempt after top consumer China announced further steps to support its beleaguered property sector. China-centric commodities, including iron ore, as well as the renminbi popped higher after China’s central bank and bank regulator jointly issued a directive to allow banks in cities with declining home prices to lower mortgage interests below the floor dictated current policies.
HG copper remains stuck between two moving averages with resistance at the 200-day at $3.8525 while the 50-day offers support at $3.72. A close above the first may signal a renewed attempt to challenge key resistance in the $4 per pound area, a move we see as very likely but potentially not until later in the year.
Global growth and China Covid-19 concerns, a robust US job market pointing to further pain on the rate hike front, and not least mild winter weather across the northern hemisphere reducing demand for diesel and natural gas have all helped drive the Bloomberg energy index sharply lower during the first week of trading. Crude and fuel products have lost around 8% this week on continued concerns over the near-term demand outlook. A focus being supported by Saudi Arabia’s decision to cut its prices for crude to Europe and Asia in February amid tepid demand and competition from cheap Russian oil looking for a home, especially in Asia.
We maintain the view that crude oil will face a challenging first quarter, where Brent may spend most of the time trading below $80 before eventually recovering back towards the $90 area once the Covid cloud starts to lift in China and seasonal demand starts to pick up. In addition, we have strong doubts about the recession risk to the US economy and see demand from some of the world’s largest consumer underpin the price during a year where supply will continue to be managed by OPEC+ and US producers inability or unwillingness to ramp up production.
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