Commodity weekly: Strong week supported by geo-risks and peak rate speculation
Responsable de la Stratégie Commodity
Résumé: Commodities suffered a sharp reversal during the past week with losses seen across all sectors except grains. The weakness was triggered by the relentless surge in US bond yields, supported by another strong US job report, and a stronger dollar raising growth and demand concerns for crude oil and fuel products, as well as industrial metals, while creating a challenging environment for investment metals.
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COT update covering week to October 3
Most major commodities reversed sharply higher this week as the tragic developments in Israel raised concerns about stability in the region, thereby supporting the energy sector, not least European gas prices which surged higher. Following weeks of weakness, the precious metal sector recorded strong gains, supported by Middle East safe haven demand and several US Federal Reserve members saying the recent surge in Treasury yields has reduced the need for additional rate hikes. With the timing of peak rates moving closer, and despite a stronger-than-expected US inflation print for September, gold managed to break higher through key resistance.
Elsewhere, the grains sector traded higher for a second week after the US government lowered the size of this year’s US soybean and corn harvest leading to shrinking global inventories. Overall, all three major crops remain in their established downtrends amid abundant global crop supplies, not least from South America. Together with recent dollar strength, US exporters have struggled to compete, thereby forcing prices lower to levels that eventually will attract buying interest from overseas buyers.
Overall, the Bloomberg Commodity Total Return Index (BCOMTR), which tracks a basket of 24 major commodity futures, rose 2.1% thereby ensuring the index maintained its upward trending trajectory which started back in June. Gains were led by the four diesel and crude oil futures contracts while the absolute outlier was the EU gas future (not included in the BCOMTR) which jumped by 40% to a seven-month high. Gold, meanwhile, was heading for its best week in seven months on a combination of speculators being forced to cover recently established short and the bullish momentum attracting fresh buying interest.
HG copper meanwhile was one of just a handful of commodities trading lower on the week, under pressure from a rise in inventories at LME monitored warehouses to a two-year high and after sentiment among delegates at the annual LME week in London leaned bearish amid worries about global growth. Adding to this China’s at best patchy recovery, the short-term outlook remains challenging but with the downside risk being cushioned by an overwhelming bullish long-term outlook.
War risk premium lifts crude and fuel prices
The recent aggressive slump across the energy sector amid surging bond yields and the strong dollar accelerating demand worries saw a sharp reversal following the Hamas attack on Israel and subsequent counterattacks on Gaza. There is little doubt that a prolonged Israel-Hamas war could destabilize the Middle East, and in a worst-case scenario reduce global supply after Iran’s foreign minister warned that Tehran-backed militants could open a new front.
Elsewhere, the IEA in their monthly oil market report said that oil’s recent retreat from near $100 a barrel showed prices had climbed to levels that could see demand start to suffer, while OPEC repeated its projection for a record 3 million barrels a day deficit this quarter. Meanwhile, the EIA reported an increase in US oil production to a record 13.2 million barrels a day and the biggest weekly inventory jump since February with refineries operating at their slowest pace since January amid seasonal maintenance.
While the macroeconomic outlook remains challenged and demand shows signs of softening, not least in the US where implied gasoline demand on a four-week average basis shows continued weakness, the prospect of a geopolitical-led supply disruption and continued production restraint from OPEC+ will underpin prices in the weeks ahead.
Having fought so hard to support the price, and in the process giving up revenues, Saudi Arabia and its Middle East neighbors are unlikely to accept much lower prices. This leads us to believe support in WTI and Brent will, and probably already has been established ahead of $80. Barring any geopolitical disruption, the upside for now seems equally limited while the bear steepening of the US yield curve continues to raise stagflation concerns and, with that in mind, Brent may once again settle into a mid-80’s to mid-$90s range, an area we for now would categorize as being a sweet spot, not too cold for producers and not too hot for consumers.
Following a near 15% correction at the start of October, renewed Middle East tensions and fear of supply disruptions have seen Brent crude higher towards $90. Making any predictions for the coming weeks is somewhere near impossible, but we do note that GCC producers, led by Saudi Arabia, hold a very elevated amount of spare capacity that can be released in a worst-case scenario – should they choose to do so.
EU gas prices jump on winter supply worries
The European TTF benchmark gas futures jumped the most since last summer as the war in the Middle East led to a disruption of supply from Israel via Egypt, and Finland suspected a gas pipeline leak in the Baltic Sea was sabotage, fueling concerns about the safety of Europe’s energy infrastructure ahead of the peak winter demand period. This follows the explosions on the Nord Stream pipelines from Russia to Germany last year, for which responsibility has yet to be determined.
The +40% surge above €50 per MWh for the first time since March, however, got underway after Israel ordered Chevron to shut production at the Tamar gas field. The site supplies pipelined gas to Egypt some of which is then converted into LNG and shipped to Europe. While the disruption is likely to be temporary it nevertheless highlights Europe’s increased dependency on gas imports from other countries than Russia.
Improved gold fundamentals just as speculators turned bearish
Gold was heading for its biggest weekly gain in seven months, driven by safe haven demand in response to the tragic developments in the Middle East and Federal Reserve members preparing the market for a peak rate scenario. Prior to the bounce, gold had seen a +130-dollar slump to near key support above $1800. As a result of this weakness, hedge funds ended up holding a net short ahead of the bounce that followed the Hamas attacks on Israel.
The latest slump culminated following another surprisingly strong US job report supporting the higher-for-longer narrative and which saw long-end US Treasury yields reach fresh multi-year highs. Since then, however, yields have started to reverse lower driven by the tragic events in the Middle East and comments from several Fed members mentioning the tightening impact of rising bond yields reducing the need from the FOMC to hike rates further. Both developments have forced hedge funds to reverse the recently established net short position back to a long.
In our recently published outlook for the fourth quarter, titled “Bond. Long bond(s)”, our core thesis is that real rates are too positive, creating a fallout from sectors and consumers with refinancing needs. As spending is likely to slow and the US fiscal cycle is turning from tailwind to headwind, the world may indeed have reached ‘peak rates’, providing a four-decade opportunity to go long bonds. On bonds, we also noted that the stagflation risks and ‘higher for longer’ observed through inflation expectations and lately driven by higher energy prices may pose a timing threat to our long bonds theme. However, an economic downturn, as the lagged effects of the recent rate hike cycle kick in, will force central banks into cutting interest rates, lowering the short-end of the US yield curve and, as the effects deepen, the long-end of the yield curve will follow lower, reflecting the need for lower long-term real rates or even negative real rates.
Despite seeing yields move higher again following a stronger-than-expected US inflation print for September, the focus in the gold market seems to be changing back to one of support, not least given the prospect of rising yields – as per this week’s Fed comments -reduces the risk of further rate hikes. In our latest precious metal update, we take a closer look at these and other recent developments supporting the improved sentiment.
Gold continued higher on Friday following an impressive week that saw no attempts to close the 10-dollar gap below $1844 that was left open on Monday. Having broken above $1885 and $1895 the next major level of resistance is not until the 200-day moving average around $1930 followed by the recent peak near $1950.
Grain prices pop but downtrends remain
The US grain and soybean sector, led by slumping wheat prices, received a small boost after the US Department of Agriculture (USDA) in a monthly report pegged the soybean harvest at 4.104 billion bushels, 42 million fewer bushels than forecast in September and 30 million bushels below an average of analysts' estimates. The price jump that followed also helped give wheat and corn prices a boost, after falling to a 3-year and 33-month low last month. The December wheat contract trades down by one-third compared to the same time last year while corn has lost 29% and soybeans only 6.5%. Similarly, these three key crops have been challenged by a summer harvest that ended up being better than originally feared, and a stronger dollar making exports from other producers more competitive, most notably Brazil and Argentina for corn and Russia and Europe for wheat.
With the northern hemisphere harvest done and the result known, the attention will be turning to South America and Asia, not least considering the prospect of La Niña causing dry conditions in Australia, a major wheat producer, while supporting production in South America as La Niña normally delivers plenty of rain.