Commodity Weekly: Energy and metals diverge ahead of year-end
Head of Commodity Strategy
Summary: The commodity sector has started December with a focus on two major developments driving energy and metals in opposite directions. Crude oil has slumped while copper at the other end has climbed with the difference being driven by diverging growth expectations in China and the rest of the world
The commodity sector started December with a focus on two major developments driving energy and metals in opposite directions. Crude oil has slumped by more than 10% while copper at the other end has climbed 3% with the difference being driven by diverging growth expectations in China and the rest of the world. Growing concerns about the economic outlook for the US, Europe and elsewhere have triggered an exodus out of long-held positions benefitting from higher energy prices while the easing of strict virus curbs in China has given a boost to China-centric commodities from copper and iron ore to soybeans.
Next week the US Federal Reserve is widely expected to deliver a 0.5% rate hike, thereby ending a run of four 0.75% increases. The meeting comes at a time when the market increasingly has become worried about the economic outlook heading into 2023. A development that has driven a gold and silver supportive drop in US ten-year yields back to 3.5%, while the yield curve inversion has reached another 40-year extreme. The agriculture sector meanwhile trades softer on the month with gains in soybeans and sugar being more than offset by losses in wheat, coffee and livestock.
Industrial metals receiving a boost from China reopening hopes
While the energy sector traded lower on concerns about the global economic growth outlook, industrial metals took comfort from the potential for an economic rebound in China, the world’s biggest consumer of metals, after the country continued to loosen Covid-19 controls while rolling out several measures designated to support the beleaguered property sector.
The Bloomberg Industrial metals index trades up 5% on the month so far with gains being led by zinc and copper with iron ore also seeing a strong rebound. While Dr. Copper increasingly in recent years have responded to the health of the Chinese economy, more than the global economy, the strength seen this past month remains impressive. Not least considering an expected supply surplus next year as mine supply is expected to increase and the global economy is expected to go through a soft patch.
However, the market is currently behaving as if the mentioned increase in mine supply may end up weaker than expected, and if that turns out to be correct, the market will instead look towards an emerging supply deficit in the following years supporting prices as renewables related demand picks up speed across the world. Exchange monitored stock levels in New York, London and Shanghai remain near a multi-year low and without the expected increase in mine supply, the shortfall may emerge sooner than currently being priced into the market.
For the second time in a month, HG copper has returned to challenge resistance around the 200-day moving average, currently at $3.925 per pound, with a break above raising the prospect for the metal breaking back above $4, a level that provided support for more than year up until June when renewed China lockdowns saw it tumble below.
Wheat looking for a floor; Soybeans supported by China demand
The benchmark wheat futures contract traded in Chicago briefly touched the lowest level since October 2021 before finding support around $7.25 per bushel. The Bloomberg wheat index is currently down close to 10% on the year, after surging around 65% back in March when Russia’s invasion of Ukraine led the panic buying from consumers worried about supply disruptions.
The price weakness seen since October has been driven by a better-than-expected production outcome from the Northern Hemisphere harvest, especially from Russia. In addition, Ukraine grain export corridor has provided a great deal of relief regarding the availability of high protein wheat for human consumption. Despite floods, Australia is expected to produce a bumper year of crops including record wheat production. All developments posing tough conditions for US exporters already dealing with reduced competitiveness from the strong dollar. Despite the end of year weakness, the price of Chicago wheat remains around a third above the recent average. Soybeans meanwhile has been supported by strong demand led by top importer China, with the prospect for a reopening adding some additional support this past week.
EU gas prices remain subdued despite demand spike from freezing weather
Demand for gas is spiking with the arrival of unseasonably wintry weather in Northwestern Europe likely to spread into continental Europe next week. However, a very mild autumn and start to the winter not only helped delay the beginning of the withdrawal season but also helped ensure a rapid inventory buildup. As a result, European gas inventories at 1,000 TWh are currently 30% above the level seen this time last year.
While elevated storage levels will provide a buffer, they are nowhere near sufficient to get Europe through what may turn out to be a colder than normal winter. With that in mind imports from Norway and via LNG needs to remain elevated and following months of demand weakness from China, easing lockdowns may increase competition for LNG from Asian buyers. Much therefore hinges on consumers’ ability to keep demand in check, primarily by reducing heating in order to conserve supplies.
Following a period of stable trading around €100/MWh, Dutch TTF benchmark gas has moved higher to trade around €140/MWh, but still well below the panic levels above €300 that were reached around August time when Russia cut supplies through its major pipelines supplying gas to Europe. Power generation from wind turbines meanwhile is creating a great deal of volatility given its unpredictability. The need for higher gas usage when the wind speed slows has seen the cost of power surge higher during the past couple of weeks. An example being one-month German power which briefly traded above €400/MWh this week, a doubling in price during a two-week period.
Crude oil dropped to a one-year low with Brent crude briefly trading below $76 and WTI below $72, a loss of more than 10% so far this month. A weakening macroeconomic outlook which has seen the US yield curve inversion extend to levels signaling an incoming recession, has overshadowed the EU embargo on Russian oil and the prospect of a pickup in demand in China as lockdowns continue to ease. Short-term technical traders looking to squeeze existing longs remain in control as the overall level of participation continues to fall ahead of yearend. Next week Russia will announce how it intend to counter the introduced price cap with the risk of a production cut potentially adding fresh support to the market ahead of what looks like a challenging 2023 where supply worries in our opinion will keep prices elevated, despite the risk of lower demand.
Precious metals led by silver, given its link to rising industrial metals, trade up on the month supported by falling treasury yields and a weaker dollar amid worries about an incoming economic slowdown. The market will focus on next Wednesday’s FOMC meeting, and prior to that the release of November CPI data on Tuesday. The metals have both seen a shift in sentiment during the past month with the selling into strength strategy, adopted for months, being replaced by one of buying into strength. In gold we will be looking out for a challenge at key resistance at $1808 with a break setting up the potential for a further gain into 2023.
This week we published Saxo’s annual batch of Outrageous Predictions, titled “2023: The War Economy” and among the ten OP’s we included one that argues that under an extreme set of circumstances, gold could reach $3,000 per ounce in 2023.
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Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.