Commodity weekly: Bottoming out?

Overall, the Bloomberg Commodity Index remains down 8% on the year with losses being led by the energy sector, not least a 56% slump in US natural gas, as well as industrial metals suffering from a so far, less commodity intensive post-pandemic recovery in China. Meanwhile, the agriculture sector trades close to flat on the year with losses in grains being offset by higher livestock prices and a massive 26% rally across the softs sector with sugar up 45% while Arabica coffee and cocoa both have rallied by more than 20%.

The global economic outlook remains clouded by recession fears and doubts about the short-term direction of US rates, not least after central banks in Australia and Canada re-started their rate hike cycle this past week. In addition, a sputtering Chinese economic recovery being less commodity intensive than previous government supported growth sprints have also been weighing on prices. However, from the recent price performance seen across the different sectors we may have seen the first signs of markets starting to bottoming out with current price levels already pricing in some of the worst-case scenarios.

In addition, the prospect for additional stimulus in China continues to gather traction following surprisingly weak PPI and CPI prints this past week. The data underscored just how difficult it has been for China to bounce back from the Covid-19 lockdown and with youth unemployment currently above 20% the need for additional support from the government and central bank may be needed to support economic growth.

El Niño has officially begun says NOAA, raising weather and crop fears

The National Oceanic and Atmospheric Administration issued an El Nino advisory on Thursday, announcing the arrival of the climatic condition. Having formed a month or two earlier than most El Niños “gives it room to grow,” and there is a 56% chance it will be considered strong and a 25% chance it reaches supersized levels, said climate scientist Michelle L’Heureux, head of NOAA’s El Nino/La Nina forecast office. El Nino strongly tilts Australia toward drier and warmer conditions with northern South America — Brazil, Colombia, and Venezuela — likely to be drier and Southeast Argentina and parts of Chile likely to be wetter. India and Indonesia also tend to be dry through August in El Niños.

Asia looks set to be in for some punishingly hot weather in the coming months as El Ninõ returns. The anticipation of this weather phenomenon starting to be felt from around July has already seen the Australian government cut its wheat production forecast for the coming season by about a third. Hot and dry weather across Asia has already up until recently been giving sugar and Robusta coffee a strong boost while adverse weather in Florida has seen the price of frozen orange juice concentrate hit a record high amid outlook for the smallest crop in 60 years.

Key crops on the move amid rising weather concerns

After weeks and in some cases months of price weakness, the grain and soybean sectors have started June with strong gains, led by growing concerns that a current dry spell across Northern Europe, the Black Sea region and parts of the US may negatively impact this year's crop production. Still down by around 20% on the year, Paris Milling wheat has led from the front, up around 7% while Chicago wheat has seen a 5.5% gain so far this month, in the process potentially creating but not yet confirmed low in the market.

Lack of rain is also hurting spring wheat in Russia, the world’s top exporter following last year’s bumper harvest, while planting of winter wheat in Argentina is facing some challenges and potential major downgrade. In addition, the fighting between Russia and Ukraine has led to the destruction of a giant dam raising fresh fears about Black Sea supplies from the war-torn area. Yet the overhang of Russian wheat supplies from last year’s bumper crop is likely to continue to weigh on old-crop prices while supporting new-crop prices through a rising premium between the two. An example being the CBOT July-December wheat spread where the new-crop December contract is currently trading 30 cents above the old-crop contract of July. A further deterioration in the outlook could see the new-crop premiums rise further.

On Friday after the writing of this update, the US Department of Agriculture released its monthly World Agriculture Supply and Demand report, and while it is still early days the market was looking for any changes in the US government production estimates for the coming season, as well as production in South America where drought in Argentina has seen corn and soybeans projections being downgraded on an almost monthly basis.

CBOT Wheat with the July-December spread inserted

Copper recovers to challenge resistance

Copper prices in New York and on the London Metal Exchange both rose for a second week to challenge a former floor now resistance, in High Grade at $3.822/lb and LME at $8440/tons. The higher move was supported by the stimulus speculation mentioned and reports showing a stock level decline to a five-month low at warehouses monitored by the three major futures exchanges in New York, London and Shanghai. The latest decline was driven by a steep drop in Shanghai to a December low.

Additional China stimulus or not, we view the current copper weakness as temporary as the green transformation theme in the coming years will continue to provide a strong tailwind for copper – the best electrical-conducting metal towards the green transformation which includes batteries, electrical traction motors, renewable power generation, energy storage and grid upgrades. Not least considering how producers face challenges in the years ahead with lower ore grades, rising production costs and a pre-pandemic lack of investment appetite as the ESG focus reduced the available investment pool provided by banks and funds.

Crude oil trades steady with demand concerns offsetting Saudi supply cut

Crude oil traded sideways for a second week as traders continued to gauge the impact of Saudi Arabia’s going it alone action to support prices at the recent OPEC+ meeting. Overall, prices remain near a cycle low with Brent having been hovering around $75 per barrel for the past couple of months. Demand concerns remain a key driver and focus while additional supply is being frowned upon at this moment. An example of this was seen on Thursday when Brent and WTI suddenly fell sharply amid rumours about an US-Iran nuclear deal which, if true, would pave the way for more supply hitting the market as sanctions get removed. The story was later declared as false and misleading by the US side but the market will have another potential price negative development to worry about.

It all adds up to what could become a challenging few months for Saudi Arabia as it yields revenues and market share in order to support a rally back above $80 in Brent. For now, the de-facto leader of OPEC has managed to send a signal of support which may help prevent a deeper correction while an eventual recovery will be paved with difficulties, not least surrounding the timing and price impact of when the Saudis may try to increase production again.

For now, Brent crude oil remains rangebound and stuck in the $70’s, and to change that while sending a signal a low has been established in the market, the psychological $80 level needs to be challenged and broken first.

Gold buyers look beyond current headwinds

Gold prices continue to be directed by the ebb and flow of US economic data and with that speculation about the short-term direction of US rates. During the week, gold managed to recover after being sent lower by surprise rate hikes from the RBA in Australia and the Bank of Canada. This was followed by a spike in weekly jobless claims once again raising doubts about the direction of US rates with traders pricing in a pause from the Fed in June but a rate hike in July and one cut before yearend. Moreover, China expanded its gold reserves for a seventh consecutive month, reinforcing the sustained global demand for precious metal among central banks focusing on de-dollarize their reserves.

While not ruling out additional short-term weakness, the market is showing resilience, with silver currently outperforming gold while the miners are still struggling to find a bid amid the current stock market rally, being increasingly concentrated and centered around a few AI (Artificial Intelligence) and mega cap stocks, a situation we view with a great deal of caution as highlighted in this update from Peter Garnry, our equity strategist, titled “Equities signal calm waters, or do they?”

While the short-term outlook points to further consolidation as we await incoming economic data, we keep an overall bullish outlook for gold, driven among others by the following expectations:

• Continued dollar weakness as yield differentials continue to narrow.
• Raised risk of an incoming recession leading to a peak in Fed rates. On the three most recent occasions this occurred, it supported strong gains in gold in the months and quarters that followed
• Central bank demand look set to continue as the de-dollarization focus continues to attract demand from several central banks. One unknown is how price sensitive, if at all, this demand will be. We suspect it will be limited, with higher prices not necessarily preventing continued accumulation.
• We believe inflation is going to be much stickier with market expectations for a drop back to 2.5% perhaps being met in the short-term but not in the long-term, forcing a gold supportive repricing of real yields lower.
• A multipolar world raising the geopolitical temperature
• Low investor participation, recently reduced further, adding support should the above-mentioned drivers eventually supply the expected breakout.

Gold is currently stuck within a 50-dollar wide range with support in the $1930-35 area while the upside remains blocked by the 21-day moving average, currently at $1967, and then the recent highs around $1985 followed by $2000. In the short term, a break below $1930 could see it target the 200-day moving average at $1840, but as long the price stays above $1800, the technical outlook will continue to favour a renewed push to the upside.