Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold and silver surge at odds with other market developments, amplifying signal value
Ole Hansen
Head of Commodity Strategy
Key points
Broad commodities strength extending to a third week
Gold gets the headlines while silver picks up steam
Also in focus: US - EU natural gas price divide, coffer surge and fresh copper high
Broad commodities strength extended to a third week, and so far, this month the Bloomberg Commodity Total Return index trades up 4.4% with solid gains seen across all sectors with grains still the notable exception, amid a continued overhang of supply from last year's bumper crop. Precious metals remain the strongest sector with gold continuing to break new ground with recent solid gains in silver and platinum lifting the sector's year-to-date performance to almost 18%.
Considering the current dollar and yield strength in response to a stronger-than-expected US inflation report, it is increasingly clear the rally - apart from strong buy-on-dip momentum attracting short-term buy strategies - is being driven by investors who care less about funding cost and more about geopolitics, rising government debt piles and now also reaccelerating US inflation.
Industrial metals come second, with some of the supporting drivers for gold and silver being replicated, not least by copper which reached a 22-month high. Elsewhere, the energy sector continues to enjoy solid support with a geopolitical risk premium related to developments in the Russia/Ukraine war and current focus on Iran and Israel being supported by OPEC production restraint and tight product markets following recent Ukraine attacks on Russian refineries. The latter leading to Russian retaliation strikes against Ukraine natural gas storage facilities, which helped boost European gas prices to a two-month high.
A year-long consolidation phase, following the 2020 to 2022 surge and subsequent correction, continue to show signs of maturing. In our recently published Q2 Outlook we asked the question whether the correction in commodities is over. Since hitting a two-year low in late March, the Bloomberg Commodity Index has now rallied by close to 10% with the bulk of the increase seen during the past few weeks. There are multiple developments impacting individual commodities, some short while others may end up being more long-term supportive.
- Demand is being supported by global growth optimism after a global manufacturing PMI measure rose above 50 for the first time since August 2022. A reading above 50 suggests expansion and it is often used as a leading indicator of economic growth. The recent pick up was led by China and the USA, the world's top consumers of raw materials.
- Heightened geopolitical tensions in the Middle East on concerns Iran may strike against Israel. This focus continues to support Brent near USD 90 while adding an additional layer of support to gold and silver which in recent weeks have benefitted from investors focusing on geopolitical and financial market stability risks.
- Supply risks remain a key factor, not least across the softs sector where adverse weather in West Africa and Vietnam have lifted cocoa and Robusta coffee prices to record levels. While the supply risks in softs is current there are increased signs of supply risks emerging among key industrial metals, most notably copper and aluminium.
- Expectations for US rate cuts in 2024 continue to be hurt by signs of reaccelerating inflation, not least in the US, and with that we have seen US rate cut expectations fall from more than six 25-basis-point cuts at the start of the year to less than two currently, and it has reduced the potential boost lower funding cost would have on the general level of activity.
- Reaccelerating inflation, as highlighted this week when US inflation beat estimates for the third month in a row, supports investments in commodities, especially precious metals and those with a tightening supply outlook.
Coffee surges as cocoa attempts to stabilise continue
While cocoa’s parabolic rise above USD 10,000 per ton, from a historic average below USD 2,000 has received a lot of attention in recent months, other soft commodities are also finding an adverse weather-related bid. The Arabica coffee future reached an October 2022 high above USD 2.25 per pound this week, thereby following in the footsteps of Robusta, which trades at a record high around USD 3,875 per ton. Arabica, primarily produced in Brazil, thrives at higher altitudes, with a preference for cool temperatures and ample rainfall while Robusta grows at lower altitudes, in warmer climates with less rainfall, conditions that are found in Vietnam, the biggest grower. Prices have jumped amid adverse weather, impacting the crop size in both locations, driving down global stock levels..
US and EU natural gas prices move in opposite directions
Also, of note this past week we have seen natural gas prices in the US and Europe move in opposite directions. Both markets have in recent weeks been weighed down by a massive overhang of gas left in storage following a mild winter that saw robust gas production in the US and lower demand in Europe due strong production of power from renewable sources as well as weak industrial demand.
On Thursday, the US Henry Hub futures contract dropped the most since February to USD 1.75 per MMBtu after storage data showed a bigger than expected weekly increase, leaving total stock levels some 38% above their seasonal average. While producers have started to cut production to support the price, the overhang of supply into the summer months will likely limit the upside potential.
Meanwhile in Europe, the Dutch TTF gas benchmark contract went the opposite direction and following a prolonged period of sideways action prices headed for their biggest weekly gain since October. The trigger being Russian attacks on Ukraine storage sites, underscoring Europe’s vulnerability to supply disruptions, even at a time where inventories are very high, while the driver was a technical buy reaction to the break above USD 30 per MWh (USD 9.4 per MMBtu).
However, just like crude oil which has seen the geopolitical risk premium ebb and flow, the same will likely occur in the gas market over the summer, and without any real and sustained disruptions the price upside in our opinion seems limited, with the refilling of storage facilities a relatively easy task unless we see a strong pickup in competition for LNG from Asian buyers, in which case the price needs to stay elevated in order to compete.
Crude oil’s risk premium ebbs and flows while OPEC and IEA diverge
Crude oil prices continue to trade near five-month highs with multiple developments currently supporting prices. Among the top drivers, we find Israel-Iran tensions adding a non-quantifiable risk premium to prices, a tightening fuel product market driven by Russian refinery disruptions following Ukraine drone attacks, a firmer demand outlook, not only for energy but also industrial metals, amid a recent improvement in manufacturing data in the US, Europe and China. On top of these we have continued production restraint from OPEC supporting an overall tightening.
These developments have since mid-December supported a continued build-up in speculative positioning, reaching a seven-month high at the beginning of April. Not least driven by Brent, the contract most exposed to international developments, which has seen the net long held by money managers reach a 2-1/2-year high at 300 million barrels, a tripling since early December, just before Houthi attacks on ships in the Red Sea helped raise the geopolitical temperature.
Oil market reports from OPEC and the IEA this past week continued to highlight a major gap in 2024 demand growth expectations. While OPEC analysts, who are paid by producers looking for a high and stable price, forecast a 2.2 million barrels per day increase, being a full million higher than where the IEA, who serves the interests of developed nations that are heavily reliant on energy resources.
Gold and silver traders focus on FOMO and reaccelerating inflation
Gold continues to go from strength to strength as we are witnessing FOMO (fear of missing out) on clear display, driving the spot price to a fresh record high this week above USD 2,400. It is also increasingly clear that normal reaction functions have been abandoned with gold and recently not least silver both rallying despite the stronger dollar and rising US Treasury yields which has seen the 10-year tenor reach a five-month high above 4.5%. In addition, the prospect for US rate cuts took another hit after US inflation beat expectations for the third consecutive month.
In dollar terms gold has so far returned 15.5%, already exceeding last year’s 13% gain while gold’s ability to withstand the stronger dollar has seen even stronger year-to-date returns against most other currencies, examples being EUR (20%), AUD 22% and not least CHF and JPY, both up around 26%.
Some of the current drivers receiving a great deal of attention, are:
- Fear of missing an ongoing rally creates a strong buy-on-dip mentality, in the process reducing the risk of recently established longs being challenged.
- Geopolitical risks related to Russia/Ukraine and the Middle East still playing a supporting role
- Strong retail demand in China amid the desire to park money in a sector seen relatively immune to a struggling economy amid deepening property woes and the risk of the Yuan devaluation.
- Continued central bank demand amid geopolitical uncertainty and de-dollarization, and not least gold’s ability to offer a level of security and stability that other assets may not provide.
- In addition, the focus is changing from the negative impact of lower rate cut expectations towards support from a reaccelerating inflation outlook
As gold continues to scale new heights, the attention has turned to some of the other semi-precious investment metals, so far primarily silver which has seen accelerated buying this past week, resulting in a year-to-date gain of 21% with the price now approaching the 2020 and 2021 highs around USD 30 per ounce. This outperformance relative to gold has seen the gold-silver ratio slump to 82 ounces of silver to one ounce of gold potentially signaling an end of gold’s three-year price dominance.
Copper and copper mining stocks continue to push higher with HG copper trading near a two-year high. Over the past six weeks, the metal has steadily climbed, buoyed by global growth and demand optimism, and material downgrades to 2024 mine supply increasingly tightening market conditions. Several mining companies have announced production downgrades due to factors like increased input costs, declining ore grades, rising regulatory expenses, and weather-related disruptions.
A jump in China’s exchange-monitored warehouse stocks to a four-year high would under normal circumstances be considered as market negative, but given the current economic challenges in China, some of the increase has potentially been triggered by traders hoarding liquid traded metals like gold and copper in anticipation of further Yuan weakness.
Furthermore, the ongoing green transformation and increased use of AI applications are augmenting demand from traditional sectors like housing and construction. An anticipated initiation of a US rate-cutting cycle later this year may prompt companies, which depleted inventories last year to mitigate funding costs, to restock. We maintain our long-standing bullish stance on copper, and with copper miners also exhibiting signs of resurgence, the possibility of a fresh record high in the second half of the year appears achievable.
Commodity articles:
10 April 2024: Record breaking gold highlights silver and platinum's potential
5 April 2024: Commodity market sees broad gains, enjoying best week in nine months
4 April 2024: What's next as gold reaches USD 2,300
3 April 2024: Q2 Outlook: Is the correction over?
3 April 2024: Cocoa: A 50% farmgate price boost a step in the right direction
27 Mar 2024: Crude oil maintains support amidst array of bullish signals
26 Mch 2024: Gold's behaviour points to sustained demand
20 Mch 2024: Attacks on Russian refineries lift risk premium and crude prices
19 Mch 2024: How to add copper exposure to your portfolio
15 Mch 2024: Commodity weekly: Green shoots seen across key sectors
13 Mch 2024: Lack of catalyst pushes crude into tightening range
8 Mch 2024: Commodity weekly: Gold and silver steal the limelight
8 Mch 2024: Investing with options - Gold optionality
6 Mch 2024: How to add gold exposure to your portfolio
6 Mch 2024: Video: What happened to the gold prices?
1 Mch 2024: Grains dip, cocoa soars, gold and oil see rays of strength: February’s commodity mix
Previous "Commitment of Traders" articles
8 April 2024: COT: Speculative interest in metals and energy gain momentum
2 Apr 2024: COT: Gold and crude longs maintained amid strong underlying support
25 Mch 2024: COT: Hedge funds zoom in on crude, copper and silver
18 Mch 2024: COT: Hedge funds buying expands from precious metals to copper and grains
11 Mch 2024: COT: Specs rush back into gold, elevated yen short in focus
4 Mch 2024: COT: Underinvested speculators fuel gold's latest surge
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