WCU: Commodities back on track for a strong 2021 finish

The Bloomberg Commodity Index, which tracks a basket of major commodities spread evenly between energy, metals, and agriculture, rose for the first time in eight weeks, thereby consolidating its very strong 2021 performance, currently at 25%, the strongest annual jump since 2000. Most of the gains, however, have initially been driven by the market finding its poise following the Omicron-driven sell-off the previous week. With that in mind, it was no surprise to find the energy sector on top with crude oil recouping half what it had lost in the correction from the October peak.

Agriculture was mixed with profit taking hitting coffee after reaching a decade high, buyers returned to cotton and sugar following a recent +12% correction. The grains sector traded lower for a second week, led by wheat, which dropped to a five-week low after the USDA raised its outlook for global stocks. The drop in Chicago also helped drag down the recent highflying futures contracts for Kansas and Paris milling wheat. In its monthly supply and demand update, the US government raised the level of global wheat stock at the end of the 2022-23 season after receiving a boost from production upgrades in Russia and Australia while US export slowed with high prices curbing demand.

Industrial metals received a bid from signs of an improved demand outlook in China, despite ongoing concerns about its property sector. The industrial metal sector outlook for 2022 remains clouded with a great deal of uncertainty with forecasters struggling to find consensus, and this uncertainty also helps explain why a bellwether metal like copper has been rangebound for close to six months now.

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.

During the past few months, however, copper has in our opinion performed relatively well considering the mentioned and known worries about the economic outlook for China, and more specifically its property sector. Additional headwinds have been created by the stronger dollar and central banks beginning to focus more on inflation than stimulus. To counter Chinese economic growth concerns, the government has been turning more vocal in their support saying it plans more support for business.

With this in mind, and 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.

Gold’s less than impressive performance extended to a fourth week, and while it managed to consolidate above the previous week low at $1761, it struggled to find a bid strong enough to challenge resistance at $1793, the 200-day moving average. The yellow metal has struggled since Jerome Powell, the Fed chair, signaled a clear change in the FOMC’s focus from creating jobs to fighting inflation.

In response to the recent inflation surge, market expectations for future US rate hikes have jumped with three 0.25% hikes now priced in for 2022, with the first one expected no later than June, a year earlier than expected just a few weeks ago. It is these expectations that have seen analysts lower their 2022 price forecasts for gold, with some even now predicting the metal could fall out of favor and trade lower next year.

We do not share this view, and still see gold trading higher in a year from now. However, we fully understand the reasons as they are predominantly being led by expectations for rising bond yields driving up real yields which for several years have been heavily negatively correlated to the price of gold. Looking at the correlation below, gold should be able to weather an initial rise in real yields to around –0.75% from the current level below –1%. 

Rising interest rates will likely increase stock market risks with many non-profit high growth stocks suffering a potential violent 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.

For now, gold needs a trigger and after the November CPI print rose to 6.8%, the highest since the 80’s, the attention will turn to the December 15 FOMC meeting for additional guidance on the pace of tapering and the timing of future rate hikes. With silver continuing to underperform, having suffered a recent 14% correction, the upside potential ahead of yearend looks limited. Speculators have reduced most of the length that was added in the futures market during the early November breakout attempt but for them to return to the buy side, the technical outlook needs to improve significantly

Crude oil’s week-long recovery from the recent Omicron-related slump slowed after a study found the new variant is 4.2 times more transmissible than Delta, leading to rising infections and with those new restrictions on movements in several nations. The negative short-term impact on mobility in response to new variants has become shallower with vaccine rollouts protecting the health system from breaking down. For now, the market is expecting the Omicron virus surge, despite its high infection rate, to show the same pattern, thereby preventing a major drop in mobility and demand for fuel.  

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.

The short-term outlook depends on whether Brent and WTI can build a strong foundation above the 200-day moving averages at $73 and $69.80 respectively. No doubt that the main threat to this support remains concerns about the virus and its ability to pose a bigger threat than the Delta variant.

Natural gas: While the US gas market tried to recover from a two-month top to bottom slump of more than 40% caused by mild winter weather across Central and Eastern US, the EU gas and power market went from bad to worse. The combination of an unplanned outage temporarily cutting supplies from Norway’s giant Troll field, geopolitical risks related to Ukraine, stable winter supplies from Russia, freezing cold weather and rapidly declining stocks, all helped drive the Dutch TTF one month benchmark gas back above €100 per MWh or $34 per MMBtu.

With rising demand for coal driving the cost of EU emissions to a fresh record above €90 per tons, before suffering a 12% correction on speculative long liquidation, the cost of power has surged as well. In Germany the one-year baseload contract reached a record €192 per MWh, or more than 5 times the long-term average. Looking at the current trajectory of gas consumption and with no signs of extra supplies from Russia, the risk of inventories depleting before spring remains a major threat to the European market and the main reason why gas prices trade at levels high enough to kill demand.

The EU is expected to decide before December 22 whether investments in gas and nuclear energy should be labelled climate friendly. The design of the EU green investment classification system is closely watched by investors worldwide and could potentially attract billions of euros in private finance to help the green transition, especially given the need to reduce the usage of coal, the biggest polluter.