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...
Commodity weekly: Back in black supported by China stimulus
Ole Hansen
Head of Commodity Strategy
Summary: The Bloomberg Commodity Index head for its first weekly gain in six weeks, with the index now up on the month, with gains this past week being led by energy and industrial metals in response to China stimulus and robust US growth in a lower inflation environment. For now, however, an adjustment in speculative positions has been a major source of support for commodities recently, with beaten down markets and sectors bouncing - at this stage primarily due to short covering from hedge funds which started the year with the weakest belief in higher commodity prices since 2015
A commodities sector under mild selling pressure for a while finally found a bid this past week, driving a broad rally across most sectors, not least industrial metals and energy. The demand outlook brightened after the People’s Bank of China, in their latest efforts to prop up the economy, surprised the market by announcing a bigger-than-expected cut in its reserve requirement ratio. The move, seen as an attempt to prop up confidence in an economy suffering from disinflation, a property market slump and a recent $6 trillion stock market rout, helped trigger a stock market bounce while supporting gains in iron ore and China-centric industrial metals.
In addition, US Q4 GDP surprised to the upside, and with the inflation metrics cooling, the report did not hurt the markets’ belief in US rate cuts, with a 50/50 chance of the first being delivered at the March 20 FOMC meeting. Market sentiment has also improved with a renewed fall in US Treasury yields and a US earnings season which so far has surprised to the upside. All in all, these developments have seen the Bloomberg Commodity Index head for its first weekly gain in six weeks, with the index now up on the month, with gains this past week being led by crude oil and fuel products. At the bottom, we find EU and US natural gas, both falling amid the prospect for milder weather and with just a few weeks of winter left, the risk of a cold-weather demand spike easing.
The energy sector, heading for its best week since October, was supported by rising geopolitical risks despite Chinese authorities asking Iran to curb Houthi attacks in the Red Sea, saying that if China’s interests are harmed it could impact commercial relations with Iran. In addition, support was also provided by a big weekly drop in US stockpiles, albeit somewhat distorted by the recent cold ‘bomb’ which slowed production, imports and refinery activity, and not least news that China, the world’s biggest importer of crude oil, had stepped up efforts to support the economy. These developments saw Brent and WTI top out of their recent ranges with technical buying adding some additional upside momentum.
Industrial metals, stuck in the mud for months, made a so far unsuccessful attempt to break higher. The rally was led by the beaten down metals of nickel and aluminum, the latter finding some additional support from a possible widening of an EU import ban on Russian aluminum products from 12% to 100% in the upcoming 13th sanctions package against Russia, planned to be approved by February 24. Copper prices, meanwhile, rose with the initial rally being driven by wrong footed short sellers who recently flipped their HG copper futures position from a net long to the biggest net short since 2022.
We maintain a positive outlook for copper given the prospect of an increasingly tight market towards the second half of the year. However, given current worries about China, despite the latest dose of stimulus, and ongoing speculation about the timing, pace and depth of incoming US rate cuts, the direction for now will likely be decided by short-term trading strategies, like the short covering rally seen this past week.Short covering a key driver behind the latest bounce
Adjusting speculative positions has indeed been a major source of support for commodities recently, with beaten down markets and sectors bouncing – at this stage primarily due to forced short covering from hedge funds and CTAs which started the year with the weakest belief in higher commodity prices since 2015. Taking a look at the weekly Commitment of Traders report which covers positions and changes made by money managers across major US and EU futures markets, we find that net short positions in the week to January 16 were held in nearly half of the contracts that we track.
Grain and soy fundamentals not yet pointing to a sustained reovery
Not least the beaten down grains sector which, this past week, made an attempt to recover from a four-year low, in the process forcing the hand of hedge funds and other large speculators, who have been net sellers since November of the six major grain and soy futures traded in Chicago. The latest COT report showed an increase in the net short to 496,000 contracts, the second biggest bet on lower prices on record, and only exceeded by a 707,000-contract short in May 2019. A short position which back then subsequently helped trigger a four-week bounce back that drove the Bloomberg Grains index higher by 20%.
We estimate that the current fundamentals do not warrant a rally on the scale mentioned, simply because the timing is off with no major unknowns this time of year to trigger such a move. The current market focus is on South American weather conditions and the potential crop size while in the US with spring planting still a few months away the focus is on exports sales which has been slowing, potentially increasing the carryout at the end of the current crop year. While a low may have already been established, the prospect for a renewed rally beyond the current short covering phase seems limited but given how far the different crop futures have fallen, a short covering bounce when it occurs could still be significant.
Crude oil breaks out of the recent trading range
WTI crude oil, the best performing commodity this past week, received a boost from the technical break above $75.50, and $80.50 in Brent - forcing investors to rethink a strategy which for several weeks had seen them switch their long exposure to Brent away from WTI in the belief that production growth will continue to pressure prices in the United States while conflict in the Middle East will provide some support for prices in Europe and Asia. While the general rally in crude oil from the early December lows saw the combined net long in Brent and WTI jump by 85% to 317k contracts, the split between the two has decisively moved in favor of Brent which in the latest reporting week accounted for 72% of the total net long.Brent has also been supported by a relatively faster rise in the backwardation, the spread between front end and deferred futures contracts. An example of this is the three-month spread, currently between the March and the June futures contracts which in Brent has widened to $1.22 per barrel, giving long-only investors a three-month annualized carry of 6% while the similar spread in WTI at 0.65 per barrel only provides a 3.4% carry, a difference that matters to investors, making Brent more attractive from an investment perspective.
We maintain the view that, unless a serious supply disruption occurs in the Middle East, both WTI and Brent will likely remain range bound around $75 in WTI and $80 in Brent with no single trigger being strong enough to change the dynamics of a market that has divided its focus between growth worries, not least in China and the USA, as well as rising non-OPEC+ production on one hand and OPEC+ cuts and geopolitical risks on the other. On top of this, we may see risk appetite ebb and flow in line with changes in the expected pace of US rate cuts. In the short-term, WTI will be facing some resistance at $77.65, the 200-day moving average with the upside in our opinion being limited beyond $80 per barrel.
Silver’s tumble attracts fresh demand; gold looks to economic data for direction
The precious metals sector struggled to keep up with the gains seen across the other sectors, and while gold had a relatively quiet week ahead of Friday’s important US PCE deflator report – the FOMC’s favorite inflation indicator – silver experienced a roller-coaster week, hitting a two-month low on Monday before recovering strongly, supported by the China-stimulus-led rally in industrial metals.
Gold traded within the tightest range since December 2021, with firm support seen in the $2000-05 area, while the upside remains limited until we get a better understanding about the timing, pace and depth of future US and EU rate cuts. Until the first cut is delivered, the market may at times run ahead of itself, in the process building up rate cut expectations to levels that leave prices vulnerable to a correction. With that in mind, the short-term direction of gold and silver will continue to be dictated by incoming economic data and their impact the dollar, yields and not least rate cut expectations.
Silver, in a relatively steep downtrend this past month, tumbled below $22 on Monday, only to see a strong recovery as the lower prices helped attract fresh buying. A weekly close near or above $23 will create an interesting technical setup with the hammer candlestick pattern potentially signaling a reversal, similar to those seen on three previous occasions.
Commodities articles:
25 Jan 2024: Grains up on short covering; softs supported by tight supply
24 Jan 2024: Disruption risks drive specs into Brent; distorted EIA report up next
23 Jan 2024: Silver and copper in focus after recent declines
19 Jan 2024: Commodity weekly: Middle East, US rates, Bitcoin ETFs & Freight rates
17 Jan 2024: Natural gas focus switch from cold to milder weather ahead
16 Jan 2024: Data dependent precious metals continue their bumpy ride
12 Jan 2024: Commodity Weekly: Geopolitical risks lift crude and gold prices
9 Jan 2024: Q1 Outlook – Year of the metals
5 Jan 2024: Commodity weekly: Bumpy start to 2024
4 Jan 2024: What to watch in crude oil as 2024 gets underway
4 Jan 2024: Podcast: Crude oil and gold in focus as a new year begins
21 Dec 2023: Weather, rates and unrest paint muddy picture for commodities in 2023
19 Dec 2023: Crude and gas pop on Red Sea Disruption Risks
14 Dec 2023: Fed's dovish tilt adds fresh fuel to precious metals
13 Dec 2023: Video - Why gold may enjoy a Santa rally for the 7th year in a row
12 Dec 2023: Video - Investing in Uranium
1 Dec 2023: Commodity weekly: Tight supply risks boost copper; OPEC+ struggles to control crude
30 Nov 2023: Precious metals take top spot for a second month
23 Nov 2023: A nervous crude oil market awaits OPEC's next move
23 Nov 2023: Podcast: Will Santa deliver another golden gift
22 Nov 2023: Will gold and silver see another Santa rally?
17 Nov 2023: Commodity weekly: Crude overshoots; silver the comeback kid
Previous "Commitment of Traders" articles
22 Jan 2024: COT: Commodities short-selling on the rise amid China woes and Fed caution
15 Jan 2024: COT: Grains sector slump continues; Mideast risks lift crude demand
8 Jan 2024: COT: Weakest commodities conviction since 2015
18 Dec 2023:COT: Crude long hits 12-year low ahead of FOMC bounce
11 Dec 2023: COT: An under owned commodity sector raising risk of an upside surprise in 2024
4 Dec 2023: COT: Speculators add further fuel to gold rally
20 Nov 2023: COT: Crude selling slows, grains in demand
14 Nov 2023: COT: Crude long slumps; agriculture sector in demand
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