Commodity Weekly: Bullish gold argument continues to strengthen

So far, the commodity market’s reaction this month to these developments has gone down different routes with precious metals rallying as they benefitted from collapsing yields and safe-haven demand. Meanwhile, the energy sector, exacerbated by a big slump in natural gas, traded lower on growth and demand concerns. In addition, the strength of the moves, both up and down, were to a certain extent dictated by the size of positions held by speculators. Gold and silver’s sharp correction during February helped drive a major reduction in bullish bets, and the sudden improvement in the technical and fundamental outlook supported fresh buying. The opposite situation unfolded in crude oil where weeks of Brent buying forced a sharp turnaround, thereby potentially sending prices down by more than was justified by underlying fundamentals.

Yield tumble supports fresh demand for gold and silver

The precious metals sector trades up more than 9% this month with gold and silver returning to strength following the February correction. Rarely have we seen support from so many different corners emerge at the same time and, with that in mind, the recent rally makes perfect sense while also increasing the prospect for even higher prices in the months ahead.

Dollar and yield-sensitive gold and silver have been supported by a 3.5% drop in the dollar, a 110 basis point collapse in the two-year US government bond yield, and a change in outlook for US Fed funds from an additional 100 basis point hike—of which 25 was delivered last week—to expectations for a 150 basis point rate cut before May next year. These changes are truly historical and they have forced a strong buying response from hedge funds who had been net sellers of gold throughout the February correction. The exchange-traded fund sector, which saw 465 tons of selling during the past eleven months, finally saw buyers return—but with only 33 tons bought during the past few weeks, it highlights the current level of underinvestment in gold.

Gold made a swift return to $2000 for the first time in a year while reaching a record against the AUD and a near record against the euro. Looking ahead, the outlook for gold and silver remains supportive, buoyed by falling yields and safe-haven demand driven by banking and real estate sector concerns. A sustained break towards and above last year’s record high at $2070 may not occur until the market feels comfortable that a peak in rates has been reached. With that in mind, we need to be focused on the Federal Reserve’s actions and communication as well incoming economic data, especially those related to inflation.

Copper attempting a breakout supported by lower stockpiles and China demand 

Trafigura, the world’s largest private metals trader, has forecast that copper will surge to a record high this year as the rebound in China will continue to deplete already low stockpiles. This view is shared by other major mining companies and physical traders, not only driven by constrained supplies and China’s rebound but also expectations of rising demand for electrification as part of the green energy transition—which will increase over the coming years.

As seen in the March performance table, copper trades close to unchanged while crude oil, another key growth and demand-dependent commodity, has slumped by more than 10%. In our opinion, this highlights a metal where rising demand from electrical vehicles, renewable power generation and energy storage and transmission is already offsetting the property slowdown in China – which has been  a key source for demand in recent years – and an economic slowdown in the West.

During the past four weeks visible copper inventories, i.e. those monitored by the futures exchanges in Shanghai, London and New York, have declined by one-quarter to 247,000 tons, a year-on-year decline of 34%. If the present trend of surging demand in China continues, Goldman Sachs says visible global copper stockpiles could be depleted by August.

HG copper has traded within a downtrend since mid-January, driven initially by disappointment over the pace of the economic recovery in China and growth concerns elsewhere. This week, a continued drop in warehouse-monitored stocks supported a strong recovery with resistance around $4.15 so far preventing a fresh breakout attempt. For now, the banking crisis and general lack of risk appetite is likely to keep prices rangebound, before eventually seeing them break higher towards last year’s record high, a development that may not occur until the second half of the year.

Crude oil challenged by continued loss of risk appetite

The banking crisis that has roiled financial markets this month has particularly impacted the energy sector, with WTI and Brent crude oil trading down by more than 10% while natural gas lost close to 20%. Crude oil’s dramatic response to the liquidity crisis has, to a large extend, been driven by developments in the weeks prior to the collapse of Silicon Valley Bank. During this time, months of range bound trading had lowered volatility, thereby supporting bigger risk taking, and with the forward curves in backwardation – supportive for those holding long positions especially in Brent – speculators had been accumulating longs while cutting short positions.

As the crisis emerged, crude oil broke support and that opened the floodgates to selling, not only from the long liquidation but also from fresh short selling attempts. In the week to March 14, speculators sold a combined 117,000 contracts of crude oil futures, the equivalent of 117 million barrels, and making it one of the three biggest weekly reductions since 2017. The prospect for higher crude oil prices has not died a sudden death but, as the IEA wrote in their latest Oil Market Report, the oil market is currently caught in the cross currents with supply outstripping still-lacklustre demand and driving inventories to an 18-month high.

We note that the price supportive backwardation in Brent was maintained during the March sell-off while refinery margins have widened, both highlighting market conditions that if maintained will continue to provide underlying support. Overall, however, there is no doubt that the coming months are likely to be challenging, with the focus on financial market stability offsetting underlying strength in demand from China and a potentially weaker dollar supporting the growth outlook in emerging market economies. 

The weekly WTI crude oil chart shows how the market continues to challenge the 200-week moving average, currently at $66.25, with a close below this potentially signalling additional weakness towards the technically important $62 area. The US government is looking for ways to refill its strategic reserves, a task that earlier this week was said could not be done this year. However, a deeper correction below $70, the level mentioned as the maximum the government is prepared to pay, could see some support emerge, not only from SPR buying but also OPEC+ getting increasingly uncomfortable with the weakness, which they do not see as warranted given the current supply and demand outlook.

The weekly WTI crude oil chart shows how the market continues to challenge the 200-week moving average, currently at $66.25, with a close below this potentially signalling additional weakness towards the technically important $62 area. The US government is looking for ways to refill its strategic reserves, a task that earlier this week was said could not be done this year. However, a deeper correction below $70, the level mentioned as the maximum the government is prepared to pay, could see some support emerge, not only from SPR buying but also OPEC+ getting increasingly uncomfortable with the weakness, which they do not see as warranted given the current supply and demand outlook.

Natural gas prices remain under pressure into the storage shoulder season.

One of the world’s most important sources of energy, continues to fall, not least in the US where the price of Henry Hub natural gas has slumped to a 30-month low near $2 per MMBtu, and is down close to 80% from the $10 peak recorded last August. A mild winter and robust production above 100 billion cubic feet on most days so far this year has seen inventory levels rise to 1,900 trillion cubic feet, some 22.7% above the long-term average.

In Europe, the Dutch TTF benchmark gas contract has settled in the €40 to €50 per MWh range ($12.6 to $15.8 per MMBtu) as the continent has made it through the winter without shortages, despite the dramatic cut in supplies from Russia. In fact, just days before the injection season starts, gas storage sites are around 55% full, well above the 25% level seen last year and 29% seen in 2021. Gas for delivery during the October 2023 to March 2024 winter period continues to trade around €50/MWh, higher than in recent years, with the need for LNG and gas reduction initiatives still required. In the short-term, the economic slowdown may add another layer of downside pressure on prices, with lower prices in recent months not necessarily being met by higher demand from energy-intensive industries.

Dramatic shift in hedge funds’ sentiment towards the grain sector

With the CFTC’s reporting of weekly hedge fund positions finally up-to-date following the late January cyber-attack, we can finally gauge their response to the price weakness seen during this time – especially the four-week period to March 14 when the BCOM grains index slumped 7%. Overall, the combined net positions in US grain and oilseed futures and options through March 14 slumped to 98k lots, the lowest since August 2020, and down 82% during the past four weeks alone. Led by a record 289k lots of corn selling flipping the net to a 54k lots short for the first time since August 2020. During the four-week period corn dropped 8% and is now a strong recovery candidate should the technical and/or fundamental outlook turn more favourable.

Wheat meanwhile remains out of favour, with hedge funds holding the biggest net-short in CBOT wheat since 2018. Despite a prolonged period of drought hampering some key US winter-wheat growing regions, the price has generally been under pressure due to a lack of competitiveness with an abundant amount of cheaper priced Russian wheat and the recent extension of the Ukraine grain corridor deal also adding supplies to the market. Down more than 50% from the record highs reached around this time last year, the current price around $6.8 per bushel still remains well above the pre-invasion average around $5.4 per bushel.

On Friday, however, the price managed to rally more than 5%, the biggest gain in a month on signs that Russia is considering asking growers to slow sales and as the mentioned dryness in the US attracts increased attention. The move higher potentially putting at risk the mentioned major short position and forcing short covering from funds.