WCU: Energy surge drives renewed focus on inflation

WCU: Energy surge drives renewed focus on inflation

Ole Hansen

Head of Commodity Strategy

Summary:  The commodity sector found a fresh bid this past week as the intense and potentially price-negative focus on China Evergrande Group, and its ability to service its debt, faded. While industrial metals recovered on the fading China focus, a fresh spike in bond yields together with a firmer dollar hurt investment metals already reeling from the lack of diversification demand from funds looking at financial assets and valuations near an all-time high. Once again a turbo-charged energy sector attracted most of the attention with crude oil, gas, coal and power all rising, and if not arrested the reflation focus may soon make a comeback.


The commodity sector found a fresh bid this past week as the intense and potentially price-negative focus on China Evergrande Group, and its ability to service its debt, faded. While the world’s most indebted property company could still spring a negative surprise, the continued pumping of cash into the financial system by The People’s Bank of China helped reduce contagion risks to other markets outside China.

The MSCI World index dropped 4% before recovering, thereby extending to 233 days the time gone by since we last saw a 5% correction across the global stock market. Probably a key reason why investment metals, such as gold and silver, are having such a troubled time this year. While often being closely correlated to movements in the dollar and yields, demand for gold is also inverse correlated to confidence in financial assets which currently, along with financial market valuations, remains near an all-time high.

Another development this past week that helped set the agenda for commodities, especially those with a high inverse correlation to Treasury yields and the dollar, was the sudden spike in US bond yields. On Thursday, the Bank of England set the ball rolling after hawkish rhetoric on the timing of the first rate hike wrongfooted investors. A selloff in gilts set the pace for euro-area rates before US Treasuries followed to produce the biggest one-day rise in 10-year yields in months.

Gas: One sector that remained immune to China worries and the risk of rising bond yields was the energy sector where crude oil, gas, coal and power prices continued to rally amid tight supplies and strong demand. Brent crude oil, the global benchmark, reached its highest settlement level since 2018, while in Europe the cost of benchmark Dutch TTF gas reached a record €76.5/MWh or $26/MMBtu, or $150 per barrel of oil equivalent, before a jump in EU wind generation helped put a brake on prices.

In the US, Henry Hub natural gas futures traded back above $5/MMBtu and after completing a 50% correction of the August to September surge to a 7 ½ year high, the technical outlook is once again pointing to further strength. Not least due to rising export demand for LNG and after a weekly government report showed inventories, just as in Europe, are still tight ahead of the winter peak demand period.

Source: Saxo Group

Crude Oil headed for its fifth weekly gain with multiple sources of support emerging. US hurricane Ida has removed +30 million barrels from the market and we continue to see a slow and prolonged return to pre-Hurricane levels. As a result, US crude oil and gasoline stocks have both declined to levels last seen in December 2019. Increased fuel consumption into the northern hemisphere winter due to the substitution of punitively expensive gas may further boost already recovering global demand. In addition, recent months have shown some OPEC+ members, most noticeably Nigeria, Angola and Kazakhstan have struggled to reach their production quota, thereby adding to the underlying market strength, though lower than expected supply. 

Countering the current rise, but so far with a limited price impact, was the first and historic sale of crude oil from China’s strategic reserves. In recent months, China has also been selling industrial metals from its reserves in order to combat surging input costs which have seen factory-gate inflation hitting a 13-year high. The first sale of 7.4 million barrels could be followed by more in the coming weeks with Wood Mackenzie estimating that as much as 82.5 million barrels may be offered. 

However, with this development having such a limited impact, it looks increasingly likely that Brent crude oil will reach $80 per barrel somewhat sooner than previously expected. From a technical perspective, the daily chart is showing some resistance at the July high at $77.84/b, while the monthly Brent chart is now showing a break above the downtrend from the 2008 record high, potentially a sign of more gains to follow.

Source: Saxo Group

Gold and silver continue to exhibit troubling behavior; stabilizing on falling yields, only to slump when they rise a bit. This week was no exception with gold struggling both before, and especially after, Wednesday’s FOMC meeting where Fed chair Jerome Powell delivered a surprisingly hawkish press conference, saying the Fed was ready to commence tapering from November while bringing forward the first rate hike to late 2022. The biggest drop came on Thursday when, as mentioned, the Bank of England managed to wrong-foot the market by signaling its first rate hike well ahead of the US, potentially already in February.

US ten-year yields broke higher through a key level of resistance at 1.4% while the corresponding real yield jumped 10 basis points to reach a three-month high at –0.89%. Gold is not only a metal which tends to respond to movements in the dollar and yields, both of which has been price negative for most of the year. It is also used by fund managers as a hedge or diversifier against risks across financial assets, but with financial assets and market valuations near all-time highs, this demand has faded and become a recent source of selling.

In other words, if you as an investor believes the current market confidence to be misplaced, the cost of buying insurance against it continues to get cheaper with gold presently trading near the lower end of its year-long range. Over the coming weeks we will watch yield developments closely with rising yields potentially raising renewed uncertainty across other asset classes, such as interest rate-sensitive growth stocks. Also, the continued surge in the cost of most energy sources will ultimately support our non-transitory views on inflation. For now, however, gold needs a solid break back above $1835, and until that happens, which we still believe it will, there are no major reasons to chase or add to any existing positions.  

Source: Saxo Group

Industrial metals recovered following the Evergrande-led slump which drove worries about Chinese demand, especially from the current under-pressure property sector. Iron ore, a key input to the production of steel currently at the epicenter of China’s crackdown on emissions in energy-intensive industries, traded at $110/tons on Friday following a dramatic slump which in just a few months has seen the price more than halve before bottoming out at $90/tons earlier in the week.

Copper, an important metal in the construction industry, also got caught up in the sell-off, but once again key supports around $4/lb in New York and $8600/tons in London did not get challenged before prices bounced back. We take this as another sign of underlying strength. And while Dr. Copper, one of the kings of the so-called “green” transformation, still lingers in a downtrend from the May peak, we still see the prospect for higher prices. While we wait for a greater high, initially above $4.63/lb, to attract fresh momentum buying, the risk of a deeper correction still exists, albeit somewhat reduced following the latest failed downside attempt. With this in mind, we maintain the view that copper remains a buy on fresh strength and any potential additional weakness.

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Trading in financial instruments carries risk, and may not be suitable for you. Past performance is not indicative of future performance. Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.