Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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Commodity Weekly: Fuel products join the rally in gold and copper
Ole Hansen
Head of Commodity Strategy
Summary: The Bloomberg Commodity Index traded higher for a second week, driven by continued gains across industrial metals, crude oil and fuel products. The gains which were been driven by optimism over the growth outlook in China were partly being offset by sharp losses in natural gas and wheat, as mild weather and ample supply continues to keep these two key commodities under pressure. In this we also take a look at how investors can get exposure to the commodity sector.
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The Bloomberg Commodity Index traded higher for a second week, driven by continued gains across industrial metals, crude oil and fuel products. The gains which were been driven by optimism over the growth outlook in China were partly being offset by sharp losses in natural gas and wheat, as mild weather and ample supply continues to keep these two key commodities under pressure. Meanwhile, the precious metal sector was mixed, with gold continuing higher supported by US bond yields and the dollar trading near cycle lows. Silver and platinum struggled to keep up, both recording losses – taking silver back to near unchanged on the month.
The general positive risk sentiment across commodities has been supported by a 1.6% drop in the Bloomberg Dollar index and a 0.4% slump in US ten-year yields as US inflation continues to ease, thereby supporting a further downshift in the Fed’s rate hike trajectory towards one-and-done – meaning a single 0.25% rate hike remains before the Fed pauses. In addition, 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, not least the energy sector where an already established embargo on crude sales will be expanded on February 5 to include fuel products – a development that may end up having a bigger impact on Russian supply than seen so far.
However, the main driver impacting the commodity sector is the prospect of China’s reopening, in turn driving expectations for a pick-up in demand for commodities from the world’s biggest consumer of raw materials. With activity in China unlikely to pick up in earnest until after the Lunar New Year holiday, the prospect of a lull in activity could be the trigger for a pause in the current rally – especially across industrial metals where copper has started the year with an 11% gain – before gathering fresh momentum and strength towards the end of the current quarter.
Crude oil gathering momentum supported by strength across fuel products
Crude oil prices were heading for a second weekly advance, thereby fully offsetting the weakness that hit the market during the first days of January. Prices are supported by continued optimism on Chinese demand and increasingly by strength in the product market. Gasoline and diesel are both trading at a two-month high ahead of the embargo on Russian products from February 5, and following a late December wintry blast in the US which continues to impact refinery activity.
Reports that China’s Covid caseload has peaked further boosted optimism that demand will start to recover more sustainably following the Lunar New Year holiday. Global demand expectations also received a boost as US jobless claims data supported the view that the labor market is still tight, thereby reducing the risk of a recession in the world’s biggest energy consuming economy. A jump in US crude exports and the first week without injections from Strategic Petroleum Reserves (SPR) nevertheless saw inventories jump 8.4m barrels as refinery demand struggled to recover following the late December wintry blast and outages.
Monthly oil market reports from OPEC and the IEA painted a mixed picture, although both mention the recovery in China as the main driver behind a rise in global crude oil demand this year. The IEA saw global oil demand rising by 1.9 million barrels per day – to a record 101.7 million barrels per day – with half of the increase from China following the lifting of its Covid restrictions. An overall non-OPEC+ rise of 1.9 million barrels per day led by the US, Canada and Brazil will be partly offset by an OPEC+ drop of 870 kb/d due to expected declines in Russia.Having bounced from support at the 50-day moving average at $83.77, a weekly close for Brent above $87 may signal further strength in the week ahead. This could also be the case for WTI at $81.
Gold continues higher while silver struggles
While silver struggled to keep up, gold continued to show resilience and, following a three-day pullback during which it found support at $1896, it jumped to an eight-month high at $1835, supported by US yields and the dollar remaining near new cycle lows. Gold is likely to remain supported as long as these two key sources of inspiration for momentum and machine-driven strategies continue to trade on the soft side. This is despite a continued lack of interest from ETF investors as total holdings remains near a two-year low, having seen no pickup during the past two months rally.
During the week, this chart showing the US Fed Fund rate and gold caught my attention. It shows the strong reaction in gold in the months and quarters that followed the three previous peaks in US rates during the past 20 years. The market is currently forecasting one or two further US rate hikes before pausing at or below 5%.
Should history repeat itself, gold would have a significant further upside, not least considering the prospect for last year's headwinds from a stronger dollar and rising yields reversing to add support. In addition, continued demand from central banks and the prospect of institutional investors eventually joining in remains a potent cocktail for gold. In the short term, however, the risk of a pullback continues to rise, with a break below current support at $1895 potentially signaling a deeper move lower to test the 21-day moving average, currently at $1861.
Copper is heading for a fifth weekly gain, with optimism about a pickup in demand as China reopens being supported by supply concerns. Protests in Peru are threatening supply from two mines accounting for around 2% of the world’s copper output. While visible inventories held at exchanges are low, demand is expected to rise as China recovers and the energy transition continues to gain traction. Having rallied 11% without looking back, the timing of a potential pause could be during the coming weeks when China shuts down its factories as the population celebrates the Lunar New Year and the arrival of the year of the rabbit – an animal associated with peace, prosperity, and longevity in Asia.
How to gain exposure to commodities?
There are several ways of gaining an exposure to commodities, the most widely used being through exchange-traded funds (ETF). Through these, an investor can gain access to, and track the performance of, an individual commodity such as gold, a sector such as grains, or a broad exposure to the major commodities spread across the three sectors of energy, metals, and agriculture.
Three major indices – the S&P GSCI index, the Bloomberg Commodity index and DBIQ Optimum Yield Diversified Commodity Index – have become the industry-standard benchmarks for investors in commodities.Commodity indexes: Different structures and strategy
The S&P GSCI, established in 1991, is an index calculated primarily on a world production-weighted basis. It is comprised of 24 physical commodities that are the subject of active, liquid futures markets. The weight of each commodity in this index is determined by the average quantity of production and is designed to reflect their relative significance in the world economy.Due to this structure, the S&P GSCI is very heavily exposed towards the energy sector, with 61.5% of the index currently invested in products ranging from crude oil and fuel products to natural gas.
The Bloomberg Commodity Index (BCOM), established in 1998, has a more diversified approach. This index also comprises 24 physical commodities, all represented by active futures markets. No single commodity may constitute more than 15% of the index, no related group of commodities may constitute more than 33% of the index and no single commodity may constitute less than 2% of the index as liquidity allows.
The weightings for each commodity are calculated in accordance with rules designed to ensure that the relative proportion of each of the underlying individual commodities reflects its global economic significance and market liquidity.
Finally, the DBIQ Optimum Yield Diversified Commodity Index Excess Return is a rules-based index composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world.
In our reporting, we tend to focus on the Bloomberg Commodity index, given its broad exposure across the different sectors. An example of this is precious metals, which only has a 4.1% exposure in the S&P GSCI as opposed to a 19.4% allocation in the BCOM. The below example shows the Invesco BCOM UCITS ETF and, while the price remains in a corrective descending triangle, the fact that it has so far only managed a 38.2% correction in the 2020 to 2022 rally points to a weak correction within a strong uptrend. More in this update from Kim Cramer, our technical analyst.
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