Head of Commodity Strategy
Summary: The commodities sector traded close to unchanged during the first week of trading with losses across metals and agriculture being offset by gains in the energy sector. The focus and drivers behind these moves have been the negative input from the lowering of US rate cut expectations, weak economic data prints from China, geopolitical risks associated with Red Sea, as well as pockets of very cold weather across the Northern Hemisphere lifting demand for gas and power.
The first few weeks of a new trading year are always a period that should be treated with a bit of caution when it comes to looking for trading signals, direction and themes. This past week has been no exception, especially across global stock markets which have started 2024 on a defensive note, primarily driven by traders taking a rain check on the durability of the strong gains that lined the pockets of traders and investors ahead of year end. The early November focus change from additional rate hikes to the prospect of lower rates in 2024 as signaled by several central banks, led by the US Federal Reserve, helped trigger a major end of year rally in stocks with the MSCI world index up 14.5% during the final two months.
Friday’s US job report together general US economic data strength helped deflate these expectations raising doubts about the timing of the first and the depth of subsequent US rate cuts. From a near certain expectation for a March cut, swap traders have now lowered those expectations to around 50% while the number of 25 basis points cuts this year has fallen from above six to near five.
Turning to commodities, the Bloomberg Commodity Total Return index trades nearly unchanged on the week with losses across metals and agriculture being offset by gains in the energy sector. The focus and drivers behind these moves have been the aforementioned negative input from the lowering of US rate cut expectations, weak economic data prints from China, geopolitical risks associated with Red Sea, as well as pockets of very cold weather across the Northern Hemisphere lifting demand for gas and power.
Last year’s big losers have started up strongly this past week with natural gas prices rising across the world as robust winter demand helps offset bulging stock levels in the US and Europe. US gas prices trades up around 7% on the week but remain down by more than one-third compared with this time last year while in Europe, the Dutch TTF benchmark gas contracts trade down around 55% year-on-year. This follows a year where the combination of slowing demand, a mild autumn and reconfigured supply chains towards LNG instead of Russian gas have seen inventories surge. EU storage sites are currently 86.5% full compared with a five-year seasonal average closer to 70%. Meanwhile, in the US gas prices trade below $3 with US inventories ending 2023 at the highest seasonal level since 2015 following a year of record production, lower weather-related demand, and despite surging exports.
Gold has seen a relatively quiet start to 2024, trading down around 1.5% during a week that included Friday’s strong report has seen robust US economic data drive bond yields up and US rate cut expectations down. In addition, the ebb and flow of geopolitical risks associated with tensions in the Red Sea area has primarily been providing an underlying bid to gold with silver struggling to keep pace amid China related weakness across industrial metals. Developments which at one point during the week saw the gold-silver ratio hit a March high above 89 (ounces of silver to one ounce of gold). Overall, silver trades near the center of a four-dollar wide range between $21.4 and $25.4.
Following on from a surprisingly robust performance in 2023 that saw gold end up 13%, we see further price gains for the yellow metal and with that also silver in 2024, driven by a trifecta of momentum chasing hedge funds, central banks continuing to buy bullion at a record pace and not least, renewed demand from ETF investors, such as asset managers, who have been absent for almost two years amid the rise in real yields and increased carry costs. With the US Federal Reserve pivoting towards rate cuts, we see the guessing game with regards to the number of rate cuts being a major drive of volatility in the months ahead, with the current level of expected cuts being justified by a soft landing while a hard landing or recession would trigger an even bigger need for rate cuts.
We see the prospect of gold reaching a fresh record high at $2300 while silver, finding additional support from an expected rally in copper, may travel towards the 2021 high at $30, signaling a fall in the gold-silver ratio back towards its 10-year average below 80.
In our latest update covering developments across the crude oil market, we conclude that Brent is likely to remain rangebound around $80 during the coming quarter as non-OPEC+ supply and global growth concerns offset production cuts, Middle East tensions and another rise in global demand, albeit at a slower pace than last year. The OPEC+ group of producers will continue to support prices by extending and potentially deepening the current production cuts. In the process they are yielding market share while adding to the level of available spare capacity. The timing of the first and the subsequent pace of US rate cuts will add volatility to the market from macro-focused speculators.
In the previous two years, the Bloomberg Commodity Total Return Index – which tracks the performance of 24 major commodity futures, spread evenly between energy, metals and agriculture – has returned 27% in 2021 and 16% in 2022. With that in mind, it was not unreasonable, given the challenges last year, to see the index give back around 8%. Do note though that if we exclude US natural gas, which slumped 67%, from the index it would trade near unchanged on the year.
The aforementioned weakness helped drive continued selling by hedge funds and commodity trading advisors (CTA) between October to early December. The result being a slump in the net long position across 24 major commodity futures to levels last seen at the depths of the Covid crisis in early 2020 when global demand for commodities, especially fuel, fell off a cliff. While the Red Sea crisis in early December helped drive fresh demand for crude oil, the total net long nevertheless ended the year at its weakest level since 2015.
These developments highlight an increasingly under-owned asset class which struggled last year amid growth worries in China and the wider world, and a sharp rise in funding costs leading industries to reduce excess inventories. It also highlights a sector which, given the right circumstances, may rebound in 2024 once the technical and/or fundamental outlook becomes more supportive, thereby leading to fresh buying and short covering. Drivers that may trigger such a change could be rate cuts lowering the funding costs and with that the inherent contango leading to industry restocking of inventories, OPEC maintaining a tight control of the supply of crude oil, and not least signs of tightness across key commodities that will help offset the risk of an economic slowdown across key economies.
On December 26 managed money accounts held a 409,000 contracts net long across 24 major commodity futures contracts split between energy (356k), metals (179k) and agriculture (-126k). Long positions were held in 15 while the 9 net short positions were mostly held across the agriculture sector led by grains. The biggest long positions based on a notional dollar value were gold ($28 bn), crude oil ($25.6 bn), RBOB gasoline ($6.3 bn) and Arabica coffee ($2.9 bn) while the biggest short positions were corn (-$4.3 bn), wheat (-$1.9 bn) and natural gas (-$1.7 bn)
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