Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
Commodities weekly: Gold remains strong as China's weakness drags on other markets
Ole Hansen
Head of Commodity Strategy
Key points in this update:
- Momentum crash slashed funds' commodities exposure to a decade low
- The world is drowning in soybeans as US production outlook receives a boost
- Copper's month-long correction fades as supply risks return
- Iron ore challenged by slump in China steel output
- Gold remains resilient despite reduced calls for aggressive US rate cuts
- Crude oil recovery runs out of steam with focus on Iran and OPEC+ cuts rollback
Global financial markets have made a strong recovery, with early August's market turmoil now a distant memory. This turnaround comes after better-than-expected US economic data reduced fears of a severe downturn in the world's largest economy, thereby easing pressure on the Federal Open Market Committee (FOMC) to implement deep interest rate cuts. However, China, the world's top consumer of commodities, remains weak due to a persistent property slump, rising unemployment, and weak consumption.
These developments should prompt caution regarding the commodities sector from a demand perspective. However, the supply side of key commodities might find support from geopolitical events, adverse weather, industrial action, and the weakest hedge fund positioning in more than a decade, which could spur fresh demand and price support in the short term.
The recent market recovery also extended to the commodities sector, with the Bloomberg Commodity Total Return index heading for a second weekly gain before Friday weakness across the energy sector dragged it back to unchanged on the week. This followed a two-month correction that culminated at the start of the month when the Bank of Japan triggered a momentum and deleveraging crash that briefly saw the index touch a 15-month low.
Gains this past week were led by copper, driven by strike action in Chile, and Arabica coffee due to a Brazil frost scare. Conversely, iron ore hit its lowest levels since 2022, amid fears that China's steel industry crisis would hurt demand, while soybeans slumped to a four-year low after the US government raised the prospect of a record crop this year. As a result, the Bloomberg grains index traded down 2.4% on the week and 21% for the year so far.
Momentum crash slashed funds' commodities exposure to its lowest in a decade
Large speculators, such as hedge funds and Commodity Trading Advisors (CTAs), do not control commodity prices but tend to anticipate and amplify price changes set in motion by market fundamentals. These traders often buy into strength and sell into weakness, resulting in significant long positions near market peaks or large short positions ahead of troughs. This behavior recently contributed to a massive exodus from the sector, culminating in the week of August 6 when weekly Commitment of Traders (COT) data showed hedge funds held a net negative position across 26 major commodities futures contracts for the first time in at least a decade.
The main driver behind this reduction in bets on higher commodity prices has been the grains sector, where near-record short positions have been held to capitalize on price slides to near four-year lows. However, the past month also saw aggressive selling in energy as crude prices slumped and fuel demand showed signs of weakness. This selling reached a peak during the week of August 6, when investors cut their petroleum positions across all major crude and fuel contracts to 194,000 contracts, the lowest level since at least 2011, and down 73% from the most recent peak in April.
The sell-off was the fastest since Q1 2020, when the global economy briefly contracted due to the spread of the coronavirus. However, this rapid exodus, especially in energy and key metal contracts (excluding gold), created a potentially attractive entry point for new long positions. This may explain the strong bounce seen across most sectors, except for grains, which are likely to continue suffering from an overhang of supply in the coming months.
The below charts show the short, long, and net positions held by speculators across a number of commodities, with the most recent print from 6 August. They highlight some of the recent selling that has been seen across the different commodities sectors, with the most notable exception being gold, as funds steadfastly hold onto an elevated long position valued at around USD 46.5 billion.
The world is drowning in soybeans
The grains sector continues to trade near a four-year low following a report projecting US farmers would harvest another large crop at a time when demand from China, a major importer, is slowing. Earlier this week, soybean futures in Chicago dropped to a four-year low below USD 10 per bushel after the US Department of Agriculture (USDA) released a monthly update showing US production could reach a record high this year. The USDA also projected a record-large corn yield, despite total output being slightly lower than last year due to a smaller planted area.
US wheat prices remain near a four-year low, with the negative price impact of a bumper US winter wheat crop partially offset by developments elsewhere, such as a much-reduced French crop and the Russia-Ukraine conflict. Overall, the USDA projected world ending stocks by August next year would show a world awash with soybeans, with stocks increasing to 134.3 million tons from the 127.8 million expected a month ago, while world stocks of corn and wheat were trimmed slightly.
Copper rally as supply disruptions mount
Copper futures in London and New York showed their first weekly advance in six weeks as US recession fears eased and strike action at BHP’s Escondida mine in Chile, the world’s largest, shifted the focus from weak demand to supply disruptions. Additionally, exchange-monitored warehouse stocks saw their first, albeit small, weekly drop since May. These developments spurred fresh demand from momentum-chasing funds, who had recently cut their net long exposure in the High Grade futures contract by 91% to a five-month low.
The Escondida mine accounts for nearly 5% of the world’s mined copper output, and a prolonged closure due to strike action could further tighten the concentrate market. Several other mines in Chile have yet to finalize wage discussions, and combined with the positive long-term outlook for copper demand, these factors suggest an end to the recent deep correction.
Iron ore challenged by slump in China steel output.
The near 3% rally in copper helped drive the industrial metal sector to the top of the table together with precious metals with silver seeing some relative strength to gold. Other metals, such as steel, fared worse, leading to a nearly 9% drop in iron ore futures to levels not seen since 2022. Crude steel production in China is showing a year-on-year decline as the property sector crisis continues to sap demand. This led to a warning from China Baowu Steel Group—the world’s largest producer—that current conditions are worse than the downturns in 2008 and 2015.
Resilient gold bulls have their sight on USD 2500
Gold, meanwhile, continues to gain, with investors showing limited selling appetite despite fluctuating US rate cut expectations. Gold's resilience highlights its appeal as a hedge against turmoil, supported by factors beyond just the timing and extent of US rate cuts. The yellow metal is heading for a weekly gain despite strong US economic data, which has eased fears that the Federal Reserve has fallen behind the curve and would need to cut rates aggressively to catch up. Gold faces resistance in the USD 2475 to 2480 area, while support is found around USD 2350 and just below USD 2300.
We maintain a positive view on gold as a diversifier and hedge against market turmoil, combined with continued demand from central banks and investors worried about elevated government debt levels. If the Federal Reserve begins cutting rates, potentially as early as next month, interest rate-sensitive investors may return to gold via ETFs, which have seen consistent net selling since 2022 when the FOMC began its aggressive rate-hiking campaign.
Crude oil recovery runs out of steam, focus on OPEC+
Brent crude, the global benchmark, has stabilized around USD 80 after weeks of selling ended near USD 75. The subsequent bounce attracted fresh buying from speculators who had recently cut their net long position in Brent crude futures to near neutral at 25k contracts, the weakest belief in higher prices since 2011.
A softening demand outlook for crude oil, especially from refineries in China, and US recession concerns, have driven crude prices well below the levels desired by OPEC+, a collective group of producers aiming for higher prices to support their economies. However, maintaining these price levels has been challenging, and it seems likely that OPEC+ will abandon plans to increase production from October.
The slowdown in Chinese demand, particularly the drop in July oil refinery output to the lowest level since 2022, has increasingly made OPEC’s forecast for a +2 million barrel a day increase in 2024 global demand growth look too optimistic, with the IEA’s sub-1 million barrel a day increase appearing more plausible. With demand in doubt, crude prices are instead being supported by supply risks due to sustained Middle East tensions, including the risk of an Iranian attack on Israel, and Russia’s ongoing war in Ukraine.
Overall, crude oil prices are likely to remain within their well-established but narrowing ranges, with Brent between USD 75 and USD 88, and WTI between USD 72 and USD 83. The biggest downside risk remains OPEC+ as a production increase could hurt the current fragile sentiment, while geopolitical events and low participation from speculators are the biggest potential drivers for an upside break.
Recent commodity articles:
9 Aug 2024: Commodities weekly: Calm returns to markets, including raw materials
8 Aug 2024: Sentiment-driven crude sell-off eases, allowing traders to focus on supply risks
7 Aug 2024: Limited short-selling interest observed during copper's recent aggressive correction
6 Aug 2024: Video: What factors are fueling the current market turmoil and gold's response
5 Aug 2024: COT: Broad commodities sell-off gains momentum; Forex traders seek JPY and CHF
5 Aug 2024: Commodities: Position reduction in focus as volatility spikes
2 Aug 2024: Widespread commodities decline in July, with gold as the notable exception
31 July 2024: Crude's month-long slide halted by fresh Mideast worries
30 July 2024: Record demand explains gold's current resilience
29 July 2024: COT: Energy and metals selling cuts hedge fund long to four-month low
4 July 2024: Sluggish US economic indicators boost demand for gold and silver
4 July 2024: Podcast Special: Quarterly Outlook - Sandcastle Economics
2 July 2024: Quarterly Outlook - Energy and grains in focus as metals pause
1 July 2024: COT: Crude long builds ahead of Q3 while grains selling accelerates
28 June 2024: Metals and natural gas propel commodity sector to quarterly gain
26 June 2024: Crude seeks support from seasonal demand strength
24 June 2024: Copper's resilience despite China weakness
18 June 2024: Precious metals go through prolonger period of consolidation
17 June 2024: COT: Dollar long jumps; Funds start rebuilding crude long
14 June 2024: Commodity weekly: Energy sector gains counterbalance metal consolidation
13 June 2024: Oil prices steady amid divergent OPEC and IEA demand projections
10 June 2024: COT: Brent long cut to ten-year low; metals left exposed to end of week slump
3 June 2024: COT: Crude length added before OPEC+ meeting; gold and copper see profit-taking
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