Head of Commodity Strategy
Summary: A very mixed week in commodities with two distinct developments attracting most of the attention. On top, we find the precious metal sector which rallied amid the growing belief that interest rates around the world have peaked. At the other end, the prospect of a slowing economic outlook and ample supply helped send the energy sector lower, in the process reversing the bulk of the gains that were forced upon the market by unilateral production cuts earlier this year.
A very mixed week in commodities with two distinct developments attracting most of the attention. On top, we find the precious metal sector which rallied 3.8% amid the growing belief that interest rates around the world have peaked. At the other end, the prospect of a slowing economic outlook and ample supply helped send the energy sector lower by 2.6%, in the process reversing the bulk of the gains that were forced upon the market by unilateral production cuts earlier this year.
The best performing commodities were the ones that in recent months had seen fading demand and increased short selling from investors, namely platinum group metals, silver, copper, and corn, while the other end saw losses being led by natural gas and crude oil as speculators continued to reverse long positions that had been initiated in recent months following Saudi Arabia and Russia’s now failed attempt to force prices higher.
Meanwhile, the industrial metal sector also rose with copper heading for its best week since July with sentiment receiving a boost from easing tensions between the US and China, a softer dollar, and robust demand from China amid continued stimulus to support growth. The agriculture sector was unchanged with end of week profit taking in coffee and continued weakness in wheat which continues to be weighed down by ample supply from the key producers around the world, being offset by gains in corn, cotton and soybeans.
On the macro-economic front, a variety of economic data from key economies around the world strengthened the view that aggressive policy-tightening cycles from the Federal Reserve and other central banks have reached the end of the road, with the focus now turning to the timing, as well as the pace, of future rate cuts. Traders responded to softness in inflation and jobs data by raising 2024 rate cut expectations in the US and Europe to a full percentage point, with the first cuts so far pencilled in to occur sometime during the second quarter.
Traders use SOFR futures contracts to bet on the direction of US short term rates, and following this week’s events, the market is now pricing in a +1% rate cut before December 2024. The SOFR contracts also tells us that traders expect the incoming rate cut cycle will continue until December 2025, at which point the rate will through around 3.75% before rising again.
Financial markets responded to these developments by sending US long-end Treasury yields sharply lower. The dollar suffered a broad retreat against its major peers, while global equity markets rose, especially those beaten down sectors that have struggled recently amid elevated levels of debt and an increasing cost of servicing that debt. Examples of themes benefiting were energy storage and renewable energy, two areas that support demand for metals such as beaten down and under owned silver and platinum.
Broad losses across the energy sector saw the Bloomberg Energy Subindex trade down more than 2% on the week, thereby extending a four-week 10% tumble to the lowest level since July. While the latest triggers were rising US inventories and continued demand worries, the drivers were accelerated technical selling from traders being increasingly forced to reduce longs while adding fresh short positions amid a deteriorating technical outlook.
The crude oil slump to a July low accelerated after prices failed to reach safer grounds last Tuesday when a broad risk-on rally was triggered after a weaker than expected US CPI print raised the prospect for peak rates and lower funding costs. The failure to break higher gave technical-focused short sellers the confidence to mark prices lower, culminating in Thursday’s 5% slump which took the Brent and WTI into technical bear market territory, having fallen by more than 20% from the early October peaks.
According to the futures market, the short-term demand outlook is showing signs of weakening. This is most notable in WTI where the spread between the prompt delivery month and three months later has returned to a $0.4/bbl contango for the first time since July. The spread reached a $6.2/bbl backwardation back in late September when tight supply focus peaked following Saudi and Russian production cuts. The equivalent three-month spread in Brent is also toying with contango, having collapsed from around $5.7/bbl to the current $0.05/bbl.
All these developments have seen third quarter strength deflate rapidly with production cuts from Russia and not least Saudi Arabia having a limited impact on the market. From late June to late September, Brent crude oil rallied by around one-third in response to Saudi production cuts amid a quest for higher prices and OPEC estimates of a 3 million barrel a day supply deficit. However, since then, the demand outlook has weakened, thereby forcing a strong sell reaction from speculators who got caught with a big long and the smallest gross short position in 12 years. The level of speculative short positions held into a weakening market helps dictate the size of a sell off as short positions are needed to absorb selling pressure from longs trying to get out.
As we highlighted in our latest commodity weekly, we worried that the crude oil market was at risk overshooting to the downside and with Brent below $80 and WTI below $75, we believe that stage has now been reached, with Thursday’s sell-off looking like a capitulation move, potentially signalling a bottom. The latest weakness came after the EIA, in its latest update covering two weeks’ worth of data, reported a 17.5 million barrel increase in nationwide stockpiles. However, what went somewhat unnoticed was an almost identical drop in total inventories of gasoline, distillates, and jet fuel of 16.4 million barrels. Apart from implied gasoline demand rising to a supportive 9 mb/d, the highest level for this time of year since 2021, some price support may also begin to emerge as refineries come out of maintenance, thereby raising demand for crude oil.
In WTI, a return above $75 may send the first signal of consolidation while a break back above $80, and Brent above $83.50, will be required before talking about a fresh through. However, with the latest slump being driven by technical developments more than fundamentals, a potential low is in our opinion within reach with traders also having to consider the risk of a geopolitical flareup and additional action to support prices from OPEC and non-OPEC when they meet on November 26.
Gold prices recovered strongly during the past week after a much-needed correction ran out of steam around $1935, a key technical support level. However, while last month’s surge was driven by geopolitical worries and financial risks associated with surging US bond yields, the latest rebound has been driven by the assumption interest rates have peaked and will turn lower next year. These developments also help explain why semi-industrial metals like silver and platinum missed last month’s rally before taking the lead this past week.
The prospect for lower funding costs supporting liquidity intensive industries, some of which need platinum and silver, has supported a strong rebound in these two beaten down and under owned metals. In addition, the recent weakness relative to gold can also be partly explained by the absence of central bank demand for these metals. Hedge funds in the week to November 7 held a 105k contract (10.5m ounces) net long in COMEX gold futures, more than 20k above the one-year average. Meanwhile in silver funds held a near neutral position of just 2.2k contracts, some 10k below the one-year average while a small net short of 1.4k contracts were held in platinum, some 8k below the one-year average.
Apart from central bank buying, which continues at a record pace, leveraged fund accounts, such as hedge funds and CTA’s as well as investor demand for ETFs remain key in underpinning a continued rally in gold. The prospect for peak rates, once confirmed, will drive down the cost of holding non-interest paying precious metal positions, and this will be the trigger for the next move higher. Until then, we keep our patiently bullish view on gold and silver and see setbacks as a buying opportunity.
Silver trades near $24, up more than 7% on the week as speculators scramble to re-enter long positions amid an outlook for lower rates and with that the prospect for improved industrial demand. A not yet confirmed trend line from the May peak may offer some resistance at $24.25 ahead of $25 while support is likely to emerge ahead of the 200-day moving average, currently at $23.30.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
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