WCU: Commodity rally slows on China lockdowns and Fed angst

The prospect of continued supply disruptions from Ukraine this year together with US and South American weather concerns as well as the mentioned rise in the cost of fuel and fertilizers will likely led to another year of tightening supply. In Ukraine, according to UkrAgroConsult, military actions in some key production regions, closed supply lines and lack of fuel could result in a 38% y/y reduction in the wheat harvest to 19.8 million tons and 55% reduction in the corn harvest to 19 million tons. In the US, the conditions of the winter wheat crop have slumped to the worst level in a decade amid dry soil conditions while surging cost of fertiliser may negatively impact crop production in South America.

Gold traded unchanged on the week as it continued to find buyers despite a stronger dollar and Treasury yields reaching a fresh cycle high after the Federal Reserve signaled a more aggressive trajectory for rate hikes and quantitative tightening. We maintain a bullish outlook for gold, a view that has been strengthened recently by the yellow metal's ability to find fresh buying interest despite an increasingly hawkish Fed and the breakdown in the normal strong inverse relation with US real yields.

Copper, the so-called king of green metals, continues to enjoy some tailwind from other industrial metals. Most recently zinc, where the threat of shortages, especially in Europe where LME stocks are critically low, has seen the price move higher. Copper did trade near a one-month high earlier in the week after Chile, the world’s largest producer of the metal, reported a 7% year-on-year decline to 399,817 tons in February, this following a drop of 7.5% year-on-year in January.

While a tight supply outlook and the green transformation will continue to underpin prices over the coming months, the market currently must deal with negative developments in China where draconian lockdown measures to combat covid outbreaks are likely to weaken the growth outlook by more than the government had originally forecast. Once the covid cloud has lifted, the Chinese government is likely to step in with additional measures to stimulate growth and that should help off-set the impact of lower growth elsewhere caused by soaring prices and accelerated tightening from the US Federal Reserve.

After reaching a record high above $5 per pound last month, HG copper traded back to $4.5 per pound before moving higher again. The outlook for copper remains supportive with tight supply offsetting the risk of an economic slowdown. We maintain this bullish view to take prices to a fresh record high later this year. In the short term, a break below the 200-day moving average, currently at $4.41 per pound, will not ruin our bullish view, only prolong the period of range bound trading.

US and EU gas markets went in opposite directions thereby supporting a long-awaited convergence between the two. US Henry Hub reached a 2008 high near $6.50/mmbtu, driven by robust domestic demand due to unseasonal cold weather and strong export demand for LNG. Natural gas inventories shrank by 33 billion cubic feet last week, with inventories now some 17% below the five-year average, the widest gap since 2019. In Europe meanwhile, a reluctance to ban Russian gas, together with milder weather and record LNG imports have seen the price of Dutch TTF gas traded lower but at €108/MWh or $34.5/mmbtu it remains very elevated and at levels that will continue to negatively impact demand. Europe and especially Germany’s U-turn on Russian gas dependency will require high prices during the coming months in order to attract record oversea supplies of LNG.

Crude oil has drifted lower following weeks of extreme turbulence and near record prices and this week it managed to retrace most of the invasion-driven gains after breaking below the uptrend from the December low. There are several reasons why the market focus has, at least for now, turned away from the loss of Russian barrels.

The four major factor, some of which are temporary, being 1) EU avoiding adding Russia crude to its growing list of sanctioned products, 2) China’s worsening covid outbreak and extended lockdowns driving a temporary contraction in fuel demand, especially for diesel and jet fuel, 3) slowing US gasoline demand in response to high prices and the prospect of an economic slowdown as the FOMC steps up its battle against inflation, thereby hurting demand, and finally 4) the release of millions of barrels of crude oil from strategic reserves held by the US and other members of the International Energy Agency.

With the war ongoing and the risk of additional sanctions or actions by Russia the downside risk to crude oil remains, in our view, limited. In our recently published Quarterly Outlook we highlighted the reasons why oil may trade within a $90 to $120 range this quarter and why structural issues, most importantly the continued level of underinvestment, will continue to support prices over the coming years.