WCU: OPEC+ surprise in a week driven by omicron angst

Agriculture: Weeks of strong demand for agriculture commodities saw a small reversal as the Omicron variant and improved regional weather developments helped trigger profit taking among some the recent highflyers led by cotton, sugar and wheat. In recent weeks up until November 23, funds had aggressively been buying up food commodities while reducing exposure in energy and metals. The result being an increase in the combined long held across 13 major futures contracts to a six-month high at 1.13 million lots, representing a nominal value of $43.5 billion.

It helps to explain some of the price weakness this past week with recently established longs being reduced, not due to a change in the underlying fundamentals supporting the individual futures markets, but more as part of the general risk reduction seen in response to Omicron uncertainties.

During the week, the UN FAO published its monthly Global Food Price Index for November and it showed a 1.2% increase on the month while Year-on-Year growth slowed to a still very elevated 27.3%. The index now sits less than 0.5% below the 2011 record with last month’s increase driven by strong gains in cereals, such as wheat, dairy and sugar.

Natural gas prices around the world continue to diverge with US prices collapsing to near $4 per MMBtu while in Europe the price of Dutch TTF benchmark gas remains stuck above $30 per MMBtu driven by tight supply and strong cold weather demand. Gas prices in the US on the other hand have come under pressure from milder-than-normal weather and rising production, and this week it drove a 22% price drop, the biggest weekly drop since 2014. While the EU is already witnessing a major energy crisis which could get worse, should we see another cold winter, the US has seen its inventory levels held in underground caverns return to their long-term average, thereby almost completely ruling out the risk of winter shortages.

Crude oil witnessed a very volatile week with traders having to grapple with the risk of another virus-related drop in demand, the recent SPR release announcement and not least the response from the OPEC+ group of producers meeting on Thursday to set their production target for January. Before then, the price of Brent crude oil had slumped by 21% from the October high with very wide trading ranges reflecting a deep uncertainty in the market with prices jumping around as the Omicron news flowed ebb and flowed between bad and less bad.

Heading into Thursday’s meeting, the market had built up expectations the group would come out defending oil prices by reducing or potentially even cancelling the January production increase. Instead, they managed to pull off a remarkable feat by supporting the price while at the same time raising production by the usual 400k barrels per day. There are several reasons why they managed to pull this off:

• The market had already priced in a significant, and not yet realised, Omicron-related drop in demand
• The group kept the meeting “in session” meaning they can meet and adjust production levels at short notice before the next planned meeting on January 4
• The decision to ease political tensions with large consumers, led by the US, potentially resulting in a reduced number of strategic reserves leaving storage due to lack of demand from refineries.
• Members with spare capacity, such as Russia and Saudi Arabia, wanted to increase production, partly to off-set the short fall from producers such as Nigeria, Angola and Equatorial Guinea who are currently producing around 500k barrels per day below their allocated quotas.
• Finally, the recent slump in WTI back below $70 and even lower further out the curve may reduce the threat from US producers who could now adopt more cautious spending plans for 2022.

While potentially delayed by a few quarters, 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.

From a technical perspective, Thursday’s price action created a so-called Hammer which often signals a reversal of the recent trend. For that to be confirmed Brent crude oil would need a close back above its 200-day moving average, currently at $72.85.

Gold’s less than impressive behavior continued during a week where it failed to find a bid despite raised Omicron concerns sending Treasury yields lower and, at least temporarily, the dollar lower as well. Adding to this, an unfolding destruction of value across many so-called and up until recently very popular bubble stock names (highlighted in one of our daily podcasts here), the exodus out of these also failed to attract any safe-haven demand for investment metals.

Instead, it slumped to a one-month low at $1762, less than three weeks after its failed upside break to $1877. It highlights a market which during the past five months has seen plenty of failed breakout attempts in both directions, with the end result being a noisy, but rangebound, market struggling for direction. What could change that in the short term remains unclear with the metal on one hand finding support from persistently low real yields and raised virus uncertainties, and on the other struggling with the potential for a more aggressive inflation fighting stance from the US Federal Reserve.

Following the renomination, both Powell and Brainard, the new vice-chair, have come out showing a clear change in focus. Powell, among other comments, has said: “We know that high inflation takes a toll on families, especially those less able to meet the higher costs of essentials like food, housing, and transportation. We will use our tools both to support the economy and a strong labor market, and to prevent higher inflation from becoming entrenched”.

As mentioned, the current technical picture looks very messy with resistance now established at $1792 which coincides with the average price seen these past five months, while the nearest area of support can be found around $1760 followed by $1720.

The industrial metal sector traded flat on the week with no major price movements seen in bellwether metals such as copper and aluminum. The market focus has started to shift to what may lie in store for 2022, not least the potential price impact from slowing growth in China versus rising demand for the so-called green metals that will be key components in the energy transition away from fossil fuels to renewables.

During the past few months, copper has in our opinion performed relatively well considering heightened worries about the economic outlook for China, and more specifically its property sector which has seen near defaults as well as a slump in home sales. Additional headwinds have been created by the stronger dollar and central banks beginning to focus more on inflation than stimulus. In order to counter Chinese economic growth concerns, Vice Premier Liu He has been out saying growth this year should exceed targets, and the government plans more support for business.

With this in mind, 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.

Staying on the subject of inventories, recently we have seen stock levels of aluminum and copper at the LME fall to their lowest levels since 2007 and 2005 respectively. In fact, the six industrial metals traded on the LME are currently all trading in backwardation, and such a synchronized level of tightness was last seen in 2007.

High Grade Copper has been averaging $4.35 since April with the current action confined to a range between $4.2 and $4.5 while major support can be found in the $4 area. The lack of momentum in recent months has driven a sharp reduction in the speculative long held by hedge funds, a development that could trigger a significant amount of activity once the technical and/or fundamental picture becomes clearer.