Head of Commodity Strategy
Summary: The commodity sector is heading for a small October gain during a month that so far has offered a plethora of developments from the Middle East crisis, raising crude oil supply risks at a time of slowing global demand, the Chinese government stepping up attempts to support its economy, and US bond yields surging to multiyear highs - in the process raising the risk of something breaking. On top we find precious metals with gold leading the sector to a strong gain of 6.3%, followed by softs (5%) where cocoa and Arabica coffee both recorded a strong month on El Niño supply-related worries. Somewhat surprisingly, given the current tensions in the Middle East and raised concerns of a wider conflict impacting supply from a crucially important region, the energy sector trades lower on the month
The Bloomberg Commodity Index is heading for a small October gain during a month that so far has offered a plethora of developments from the Middle East crisis, raising crude oil supply risks at a time of slowing global demand, the Chinese government stepping up attempts to support its economy, and US bond yields surging to multiyear highs - in the process raising the risk of something breaking. Elsewhere orange juice futures kept hitting fresh records, cocoa prices reached levels last seen in the late 1970’s while sugar surged to a 12-year high.
Overall, the Bloomberg Commodity Total Return Index (BCOMTR), which tracks a basket of 24 major commodity futures, trades up 1% on the month, thereby reducing its year-to-date decline to just 2.5% from -11% back in June, before the energy sector led a recovery as OPEC+ cut production in order to support the price. On top we find precious metals with gold leading the sector to a strong gain of 6.3%, followed by softs (5%) where cocoa and Arabica coffee both recorded a strong month on El Niño supply-related worries. The grains sector (2.3%) is heading for its first, albeit small, monthly gain in three months with all three major crops trading higher, led by CBOT wheat which recently hit a +4 year low amid ample supply following a better than expected harvest across the northern hemisphere.
Somewhat surprisingly, given the current tensions in the Middle East and raised concerns of a wider conflict impacting supply from a crucially important region, the energy sector trades lower on the month, led by diesel and gasoline as the seasonal slowdown in demand has lowered refinery margins, and with that demand for crude oil. At the bottom of the performance table, we find the industrial metal sector (-4.5%) which despite a small bounce this past week in response to fresh economic support from the Chinese government, continues to suffer amid concerns about the medium-term outlook for demand growth in China and the rest of the world.
The table below shows some of the world’s largest and most actively traded commodity ETFs, their recent performance and not least recent investor flows. There are many ETFs tracking commodities so the list is by no means exhaustive and should primarily be used for information and inspiration.
The first section is UCITS-compliant ETFs and are based on an EU directive that provides a regulatory framework for funds that are managed and based in the EU, while the second part shows mostly US listed, and therefore non-UCITS compliant ETFs. It is among this group we find some of the world’s biggest ETFs in terms of market cap but also several that are registered as PTPs, which due to US taxation laws are often not offered outside the US.
Broad exposure commodity ETFs remain the main focus from investors, not least the Bloomberg Commodity Index which tracks 24 major commodity futures spread evenly across energy, metals, and agriculture. Among the US listed ETFs, the most popular currently is the DBIQ Optimum Yield Diversified which tracks a narrower group of 14 commodity futures. At the bottom of the tables, and for several months now, we continue to see outflows from bullion-backed ETFs, and below we highlight some of the reasons why this popular product has yet to react to the strong gold rally seen during the past few weeks.
From a wider economic perspective, market sentiment took a hit this past week. Global stock markets are trading defensively after several earnings results revealed the pressure on several sectors from sharply higher funding costs as the rise in US Treasury yields are being replicated around the world. While speculation about whether we have seen peak rates across the major economies continue to grow amid recession concerns and lower inflation, the continued rise in bond yields has triggered stress signals from the wider economy as it pushes up mortgage rates, hurting borrowers while causing painful losses for many investment funds and banks that could, in turn, curb lending into the economy. It is also pushing up borrowing costs across the developed world and sucking money out of emerging markets, while raising the bar for when an investment in stocks makes sense.
Within the agricultural sector, the performance gap between soft commodities - such as cocoa, coffee, cotton, and sugar on one hand, and the grain and soy sector on the other - continues to widen with the softs sector so far showing a 28% year-on-year gain, while the grains sector has fallen by 15%. Despite weather scares early in the growing season and concerns about Ukraine, a bumper crop has emerged following a strong growing season across the northern hemisphere. Lower wheat, corn and soybean prices have done a great deal to reduce inflationary pressures around the world. An improvement in forecasts across other major exporters such as Brazil and Argentina have also helped to drive corn and other grain prices lower this past week.
Another picture, however, has emerged in softs where cocoa futures have reached a 44-year high and sugar a 12-year high, both troubled by adverse weather conditions in key growing regions, from West Africa to India and Thailand, while a decimated orange juice crop in Florida has triggered a major squeeze resulting in record prices.
The EU and US natural gas futures contracts occupy the top two spots this month, both being supported by the prospect of rising heating demand, with temperatures on a downward trajectory into the northern hemisphere’s winter. In Europe, the war between Israel and Hamas has brought an unwelcome, but so far manageable supply disruption, but also with the risk of the conflict spreading, potentially reducing flows from key suppliers in the Middle East. However, with inventories 99% full and a recession light outlook cutting industrial demand, the region looks well positioned to scrape through another winter.
The February 2024 Dutch gas contract, which reflects the peak demand period when the risk of falling supplies would hurt the most, currently trades near €56/MWh ($17.4/MMBtu) or less than 10% above the current spot contract around €51/MWh ($15.8/MMBtu), indicating a reasonably relaxed market. Meanwhile, US gas trades back above $3/MMBtu, and following weeks of above-average stock increases due to the mild weather and strong production, much colder weather from next week will boost demand for heating ahead of the annual withdrawal of stocks season which normally starts around mid-November.
Gold has now fully recovered from the recent selloff to challenge $2000, a big psychological level. While geopolitical tensions following the October attacks inside Israel were the trigger, buying pressure from funds forced to flip positions back to a net long added to the strong momentum. In the week to October 17 wrongfooted speculators bought 5.7 million ounces of gold – fourth biggest in the last decade – to reverse an ill-timed short back to a 4.2-million-ounce net long, still well below the 14.8 million ounce long reached during the US banking crisis earlier this year.
It is also worth noting that total holdings in bullion-backed ETFs have yet to show any signs of long-term investors getting back in. Total holdings have been falling continuously for many months with asset managers, many of which trade gold through ETF’s, continuing to focus on US economic strength, rising bond yields and potentially another delay in peak rates as reasons for not getting involved. These factors, together with the rising cost of funding a non-interest paying precious metal position, has been a significant driver behind the year-long reduction in gold positions, and in recent updates we have argued that this trend would likely continue until we see a clear trend towards lower rates, and/or an upside break forcing a response from real money allocators for ‘fear of missing out’.
Gold trades within a very steep ascending channel, which highlights not only the current strength of the rally, but also the need for consolidation. Earlier this week, the yellow metal did correct lower, only to find support at the first given opportunity just above $1950. A close above $2000 may signal a move towards the two record closing highs of around $2050 from March 2022, and May this year.As mentioned, while the main oil market focus stays on the Middle East, underlying fundamentals have started to ease with demand heading for a seasonal slowdown, potentially made worse by an ongoing economic slowdown. Refinery margins, especially for gasoline, have fallen as we approach the low demand season thereby reducing refinery demand for crude as profitability falls. Prompt WTI and Brent spreads have more than halved, as supply fears ease, while the premium medium-sour Dubai crude commands over both light-sweet Brent and WTI have both fallen back, another sign that the market remains relaxed about the risk of a Middle East contagion.
While the upside potential remains impossible to predict, downside risks are limited by the existence of a floor beneath the market. Having fought so hard to support the price, and in the process giving up revenues, Saudi Arabia and its Middle East neighbors are unlikely to accept much lower prices. This leads us to believe support for WTI and Brent has been established and will be defended ahead of $80 and, barring any war-related disruptions, the upside for now seems equally limited. With that in mind, Brent is likely to settle into the mid-80’s to mid-$90s range, an area we for now would categorize as being a sweet spot, not too cold for producers and not too hot for consumers.
This week I returned to Macrovoices.com and during my conversation with host Eric Townsend I mentioned the reasons why we still expect commodity prices to move higher in the medium term. Several topics were discussed, including backwardation versus contango, gold’s resilience despite rising yields and dollar, industrial metals, and crude oil trends as well as the Commitment of Traders Report, what it is and how to use it.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
