Commodity weekly: Gas, gold and cocoa on top in October

ETF investors continue to favor broad over individual commodity exposure

The table below shows some of the world’s largest and most actively traded commodity ETFs, their recent performance and not least recent investor flows. There are many ETFs tracking commodities so the list is by no means exhaustive and should primarily be used for information and inspiration. 

The first section is UCITS-compliant ETFs and are based on an EU directive that provides a regulatory framework for funds that are managed and based in the EU, while the second part shows mostly US listed, and therefore non-UCITS compliant ETFs. It is among this group we find some of the world’s biggest ETFs in terms of market cap but also several that are registered as PTPs, which due to US taxation laws are often not offered outside the US. 

Broad exposure commodity ETFs remain the main focus from investors, not least the Bloomberg Commodity Index which tracks 24 major commodity futures spread evenly across energy, metals, and agriculture. Among the US listed ETFs, the most popular currently is the DBIQ Optimum Yield Diversified which tracks a narrower group of 14 commodity futures. At the bottom of the tables, and for several months now, we continue to see outflows from bullion-backed ETFs, and below we highlight some of the reasons why this popular product has yet to react to the strong gold rally seen during the past few weeks. 

Natural gas on the rise ahead of winter

The EU and US natural gas futures contracts occupy the top two spots this month, both being supported by the prospect of rising heating demand, with temperatures on a downward trajectory into the northern hemisphere’s winter. In Europe, the war between Israel and Hamas has brought an unwelcome, but so far manageable supply disruption, but also with the risk of the conflict spreading, potentially reducing flows from key suppliers in the Middle East. However, with inventories 99% full and a recession light outlook cutting industrial demand, the region looks well positioned to scrape through another winter. 

The February 2024 Dutch gas contract, which reflects the peak demand period when the risk of falling supplies would hurt the most, currently trades near €56/MWh ($17.4/MMBtu) or less than 10% above the current spot contract around €51/MWh ($15.8/MMBtu), indicating a reasonably relaxed market. Meanwhile, US gas trades back above $3/MMBtu, and following weeks of above-average stock increases due to the mild weather and strong production, much colder weather from next week will boost demand for heating ahead of the annual withdrawal of stocks season which normally starts around mid-November. 

Gold bulls take stock as $2000 looms large

Gold has now fully recovered from the recent selloff to challenge $2000, a big psychological level. While geopolitical tensions following the October attacks inside Israel were the trigger, buying pressure from funds forced to flip positions back to a net long added to the strong momentum. In the week to October 17 wrongfooted speculators bought 5.7 million ounces of gold – fourth biggest in the last decade – to reverse an ill-timed short back to a 4.2-million-ounce net long, still well below the 14.8 million ounce long reached during the US banking crisis earlier this year. 

It is also worth noting that total holdings in bullion-backed ETFs have yet to show any signs of long-term investors getting back in. Total holdings have been falling continuously for many months with asset managers, many of which trade gold through ETF’s, continuing to focus on US economic strength, rising bond yields and potentially another delay in peak rates as reasons for not getting involved. These factors, together with the rising cost of funding a non-interest paying precious metal position, has been a significant driver behind the year-long reduction in gold positions, and in recent updates we have argued that this trend would likely continue until we see a clear trend towards lower rates, and/or an upside break forcing a response from real money allocators for ‘fear of missing out’. 

Crude oil fluctuates with war risks offsetting slowing demand 

As mentioned, while the main oil market focus stays on the Middle East, underlying fundamentals have started to ease with demand heading for a seasonal slowdown, potentially made worse by an ongoing economic slowdown. Refinery margins, especially for gasoline, have fallen as we approach the low demand season thereby reducing refinery demand for crude as profitability falls. Prompt WTI and Brent spreads have more than halved, as supply fears ease, while the premium medium-sour Dubai crude commands over both light-sweet Brent and WTI have both fallen back, another sign that the market remains relaxed about the risk of a Middle East contagion.

While the upside potential remains impossible to predict, downside risks are limited by the existence of a floor beneath the market. Having fought so hard to support the price, and in the process giving up revenues, Saudi Arabia and its Middle East neighbors are unlikely to accept much lower prices. This leads us to believe support for WTI and Brent has been established and will be defended ahead of $80 and, barring any war-related disruptions, the upside for now seems equally limited. With that in mind, Brent is likely to settle into the mid-80’s to mid-$90s range, an area we for now would categorize as being a sweet spot, not too cold for producers and not too hot for consumers. 

This week I returned to Macrovoices.com and during my conversation with host Eric Townsend I mentioned the reasons why we still expect commodity prices to move higher in the medium term. Several topics were discussed, including backwardation versus contango, gold’s resilience despite rising yields and dollar, industrial metals, and crude oil trends as well as the Commitment of Traders Report, what it is and how to use it.