Commodity Weekly: Commodities shrug off banking and recession concerns

Crude oil down but not out

Brent and WTI, the world’s two leading crude oil futures contracts, managed to recoup around half of the early March losses which accelerated mid-month as the banking crisis gathered strength. However, the strength of the selloff was driven mostly by the need from speculators and hedgers to reduce their net long positions more than the market pricing in a deteriorating demand outlook, and it explains why the price – following the initial selling phase – has managed to recover back to around $80 in Brent and $75 in WTI.

Ahead of the sudden selloff, crude oil had seen months of sideways trading and thus reducing volatility, thereby forcing speculators – who target a certain level of volatility in their portfolio – to increase their positions. And with Brent trading in a supportive backwardation structure, the focus had primarily been on building long positions ahead of an expected price rally as demand improved. As the crisis emerged, crude oil broke support and that opened the floodgates to selling, not only from the long liquidation but also from fresh short selling attempts.

During a two-week period to March 21, hedge funds sold WTI and Brent at the fastest pace in more than ten years with the combined net long slumping by 233k lots or 233 million barrels of crude oil to a three-year low at 241k lots. Selling hit WTI particularly hard with the net long slumping to 71k lots and lowest since 2016. As prices began to recover with the improved risk sentiment recently established, short positions were forced to take cover.

Crude oil traded firm ahead of month-end with the recent recovery being driven by continued supply disruptions from Northern Iraq amid a dispute between Baghdad and the Kurdistan region, a weaker dollar, the biggest drop in US crude stocks since November, China’s recovery showing continued strength and an improve risk sentiment forcing short covering. In a monthly survey published by the Dallas Fed, shale oil basin executives said the “uncertainty of the depth and duration of bank crisis is causing us to be nervous about capital spending plans in 2023”. In addition to access to credit, record costs from a shortage of labour and supply chain issues have led to a slowdown in production growth.

We maintain a moderate bullish outlook for crude oil as we are concerned that most of the still expected +2 million barrel a day increase in global demand this year is forecast to occur during the second half. With that in mind, a deeper than expected slowdown, as signalled by current U.S. rate cut expectations may reduce the eventual growth, thereby reducing the upside for crude oil later this year. However, in the short term, a break above $80.40 in Brent is likely to signal a return to the range that prevailed prior to the mid-March correction.

Gold’s short-term upside potential is being challenged by the gap

Following a month of turmoil across the banking industry, gold and silver is heading for monthly gains of around 8% and 14% respectively. Despite easing tensions this past week, both metals have managed to hold onto most of their gains in anticipation of a near-term peak in US rates being followed by a succession of rate cuts. However, this outlook could be challenged by the fact that the current 60% probability of a recession is most likely to high, certainly if we hold it up against an economic reading which still sees high inflation, full employment, and resilient consumers.

Having seen the Silicon Valley Bank collapse drive a U-turn in future rate expectations from additional hikes to expectations of +100 basis point cuts in the coming months, the market seems to want to force a recession. However, in our view, the path is one of a “slow recession” rather than a collapse. At Saxo, we see no cuts between now and September, and that could leave the precious metal market exposed should economic data, especially those covering inflation, continue to show strength.

Overall, it does not change the fact that the timing of peak rates has moved a lot closer and the combination of fresh demand for gold from ETF investors, momentum buying from hedge funds and continued physical demand from central banks will likely see gold and silver mover higher once the wide gap between current and future (lower) Fed funds rates begins to narrow.

On the upside, $2000 remains the key level to watch, while support is seen at $1933, the 38.2% retracement of the recent runup to $2010. In silver, watch a weekly close above $23.90 as it may signal a breakout of a two-year downtrend.

Grains on the move ahead of key planting report.

The Bloomberg Grains index which tracks the performance of six major US grain and soy contracts reached a five-week high, driven by a 3.6% gain in corn amid a pickup in demand from China for US grain. Meanwhile, wheat briefly traded above $7 on concerns Russia may seek a temporary pause in its sales of wheat and sunflower oil to achieve higher prices. In addition, dryness across the US Plains has lifted the price of May Kansas hard-red winter wheat (HRW), thereby adding some support to the Chicago soft-red winter (SRW) variety.

Apart from these price supportive developments occurring just after speculators had been aggressive sellers, especially of corn, the market was preparing for the release of a key report from the US Department of Agriculture. The Quarterly Stocks and Prospective Planting reports were expected to show the smallest wheat and corn stocks in 15 and 9 years, respectively. In addition, a 19% reduction in the cotton acreage to 11 million acres and reductions in other smaller crops has led expectations that farmers will plant a bigger area of soybeans (1% to 88.3 million acres), corn (2.6% to 90.9 million) and not least wheat (9% to 48.9), the largest acreage allocation in seven years. Note: The result of these potential market moving reports were not known at the time of writing.

Copper remains supported by falling stockpiles and China demand 

Copper has managed to recover from losses seen during the mid-month banking crisis related sell-off. This highlights underlying demand for a metal where rising demand from electrical vehicles, renewable power generation and energy storage and transmission is already offsetting the property slowdown in China – which has been a key source for demand in recent years – and an economic slowdown in the West.

Visible copper inventories monitored by the futures exchanges in Shanghai, London and New York have declined by 29% during the past five weeks. If the present trend of surging demand in China continues, Goldman Sachs says visible global copper stockpiles could be depleted by August. Countering strong demand, we have seen global production continuing to recover from a fourth quarter slump when production troubles in Chile and Peru as well as lockdown in China triggered a 19% quarter-on-quarter reduction, the lowest output in six years according to S&P Global.

HG copper has traded within a downtrend since mid-January, driven initially by disappointment over the pace of the economic recovery in China and growth concerns elsewhere. Recently, as banking worries eased, a continued drop in warehouse-monitored stocks has seen the price settle into a $4.00-$4.15 range. Having flipped their net position from a +40,000 contract long on January 31 to a 7,000-contract short seven weeks later, managed money accounts will be forced back on the buying side should an upside breakout occur.

Finally, a warning about leveraged ETFs

Normally we do not spend much time on leveraged ETFs – products that are often ill understood by investors and have a dismal ability to track the performance of the underlying instrument over time – as they are best left alone or only used for very short-term directional trading strategies.

As humans, we are often attracted to mean reversal trades, i.e., looking for a stock to bounce following a heavy selloff. A classic example of this being the BOIL ETF which seeks daily investment results that correspond to twice (200%) the performance of the Bloomberg Natural Gas Sub-Index. During March, the ETF has, despite a 47% price collapse, managed to attract $235 millions of fresh investor flows, and to recoup that loss the ETF now needs to rise by more than 87%.

Held over an extended period, this ETF is difficult to manage and the one-year loss of 93% tells a story, not only about the current weakness in natural gas but also a very elevated contango that eats into your return at each underlying futures roll. During a five-year period, the front month natural gas contract trades down 25% while the BOIL ETF has lost close to 99% of its value.