WCU: Omicron and EU power volatility dominate focus into year-end
Head of Commodity Strategy
Summary: Commodities traded mixed during a week which saw the US FOMC deliver an expected hawkish message as they stepped up efforts to combat surging inflation. However, a vicious post-FOMC reversal in risk sentiment unfolded, driving the dollar and bond yields lower, thereby supporting a recovery among some the commodities that had been under pressure ahead of the FOMC meeting. Crude oil traded mixed with the omicron variant clouding the short-term outlook while in Europe the energy crisis showed no signs of abating with strong demand not being met by an equally strong supply response.
Commodities traded mixed during a week which saw the US FOMC deliver an expected hawkish message as they stepped up efforts to combat surging inflation. However, after presenting the market with the prospect for three rate hikes in 2022 and 2023, a vicious reversal in risk sentiment unfolded, with the euro and other major currencies outperforming the US dollar, thereby supporting a recovery among some the commodities that had been under pressure ahead of the FOMC meeting.
US Treasuries, a key directional guide for investment metals, also delivered a surprise post-FOMC reaction. Just the day after making a hawkish shift complete with a fresh series of stronger economic, inflation and Fed policy forecasts, yields dropped along the entire curve. Apart from a relief rally driven by a deeper knowledge about the thinking within the central bank, the reaction was most likely also supported by the continued and rapid spreading of the Omicron virus, with the new variant driving a surge in cases around the world.
Despite the tailwind from a weaker dollar, the oil market traded softer with short-term demand concerns related to the Omicron virus supporting the International Energy Agency in its forecast for an oversupplied market into the early months of 2022. Natural gas prices continued to diverge with mild US winter weather driving prices down to levels normally seen during the summer months, while here in Europe a perfect storm of price-supportive events helped drive gas and power prices to fresh record highs.
The result of these developments was a relatively neutral week for the Bloomberg Commodity Index, which tracks a basket of major commodities spread evenly between energy, metals, and agriculture. Thereby consolidating its very strong 2021 performance, currently at 24%, the strongest annual jump since 2001.
Precious metals received a boost after the FOMC meeting delivered the expected hawkish tilt. Both metals had been under pressure since the surprisingly hawkish acceptance speeches from Fed chair Powell and vice chair Brainard on November 22. With most of the announced actions being priced in ahead of the meeting, both metals seized the opportunity to claw back some of their recent losses. With 10-year real yields returning to pre-FOMC levels below –1% and the dollar seeing its biggest retreat since October, gold managed to break above its 200-day moving average, a level that had been providing resistance in the run up to the meeting.
The outlook for 2022 remains clouded with most of the bearish gold forecasts being driven by expectations for sharply higher real yields. Real yields have throughout the past few years shown a high degree of inverse correlation with gold, and it’s the risk of a hawkish Fed driving yields higher that currently worries the market.
However, with three rate hikes already priced in for 2022 and 2023 and with gold trading at levels which look around 0.25% too cheap relative to 10-year real yields, the downside risk should be limited unless the Fed over the coming weeks and months turns up the rhetoric and signals a more aggressive pace of rate hikes.
It is also worth keeping in mind that rising interest rates will likely increase stock market risks with many non-profit high-growth stocks suffering a potential revaluation. In addition, concerns about persistent government and private debt levels, increased central bank buying and the dollar rolling over following months of strength, are all potential drivers that could offset the negative impact of rising bond yields.
Having broken above resistance-turned-support at $1795, gold will find support from short-term momentum buyers, but for the newfound strength to extend beyond that, longer-term focused investors need to emerge, and so far, total holdings in bullion-backed exchange-traded funds are not showing any signs of picking up. Perhaps due to the time of year when only strong investment cases are being reacted upon while others are being postponed to January.
Silver also deserves some attention after once again managing to find support, and since September buyers have emerged on four occasions below $22, thereby preventing a challenge at $21.15 key support from 2016. The chart action could potentially signal a major low is in the process of being established, but for now the metal needs support from both gold and industrial metals to force a major change in the direction.
Industrial metals, just like precious metals, received a post-FOMC boost but not before once again fending off another downside attempt with copper temporarily falling to a two-month low. Supporting the recovery was news that Chinese production of aluminum for November slowed due to persistent restrictions on energy consumption, thereby driving increased demand for stocks held at LME-monitored warehouses. Copper meanwhile found support after one of Peru’s biggest mines started winding down production amid community protests hampering output.
Annual outlooks and price forecasts from major banks with a commodity operation have started to roll in, and while the outlook for energy and agriculture is generally positive, and precious metals negative, due to expectations for a rise in US short-term rates and long-end yields, the outlook for industrial metals is mixed. While the energy transformation towards a less carbon intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizable portion of Chinese demand relates to the property sector.
Considering a weak pipeline of new mining supply, we believe the current macro headwinds from China’s property slowdown will begin to moderate through the early part of 2022, and with inventories of both copper and aluminum already running low, this development could be the trigger that sends prices back towards and potentially above the record levels seen earlier this year. Months of sideways price action has cut the speculative length close to neutral, thereby raising the prospect for renewed buying once the technical outlook improves.
Crude oil dipped on Friday to trade down on the week as Omicron developments continue to impact the short-term demand outlook. A weaker dollar has been offset by tighter monetary policies potentially softening the 2022 growth outlook further. While Europe is dealing with a worsening energy crisis, milder than normal weather in Asia has led to a less demand for fuel products used in power generation and heating. With the clouded outlook we expect most of the trading ahead of New Year to be driven by short-term technical trading strategies.
With the International Energy Agency, as well as OPEC forecasting a balance market during the early months of 2022, the risk of higher prices may have been delayed but not removed. We still maintain a long-term bullish view on the oil market as it will be facing years of likely under investment with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.
The EU gas and power market surged to a new record high on Thursday before paring back gains on Friday after Gazprom booked some pipeline capacity. Before then, the Dutch TTF gas future had closed above €140/MWh or $45/MMBtu, more than nine times the long/term average, while German Power traded more than six times higher than the long-term averaged at €245/MWh.
A combination French nuclear power plants temporary shutting down due to faults on pipes, an expected cold snap next week and low flows from Russia continue to reduce already-low inventories. Adding to this is US pressure to apply sanctions on Russia over Ukraine and German regulators saying the Nord Stream 2 gas pipeline may not be approved before July.
The market is clearly driven by fears about a February shortage of gas and with this in mind the market will continue to focus intensely on short-term weather developments as well as any signs of increased supplies from Russia. An improvement in both could see prices suffer a sharp correction as current levels are killing growth, raising inflation while creating pockets of fuel poverty across Europe.