By Ole S Hansen, Head of Commodity Strategy at Saxo Bank

Dubai, UAE, September 16, 2018:  Commodities in general traded close to unchanged on the week with rising energy and metal prices being offset by lower grain prices. The weaker dollar, which came under pressure against resurgent emerging market currencies, helped at least temporary to raise the general level of risk appetite. 

The ongoing trade war between China and US did not, as expected, escalate further with President Trump refraining from unleashing tariffs on an additional $200 billion of Chinese imports. New talks have been scheduled between the two countries with a group of more than 85 US industry groups launching a coalition to take the fight against tariffs public. A campaign to convince lawmakers to fight the tariffs is clearly not what an under-pressure President needs ahead of the US midterm elections this November.   
 
Crude oil remained bid with the focus on multiple supply issues and Hurricane Florence posing a potential short-term risk to pipeline infrastructure. Gold still lacks a major spark to trigger short-covering as it spends a fifth week range-bound around $1,200/oz. Copper led the industrial metals higher but continued growth concerns, especially in China, helped keep the Bloomberg Commodity metals index close to a 13-month low. 

The three major crops of corn, soybeans and wheat all reacted negatively to the September World Agriculture Supply and Demand Estimates report from the US Department of Agriculture. The report raised its corn yield forecasts to a new record of 181 Bu/acre, thereby sending production beyond what analysts had been expecting. 

The report also confirmed a bumper soybean crop which together with Chinese import tariffs is expected to leave a record 845 million bushels in storage by the end of the 2018-19 season. Chicago wheat, meanwhile, was sent lower after the USDA unexpectedly raised Russia’s outlook. This helped lift global ending stocks above what was expected. Some however did question the USDA’s rationale behind this. Other data providers are showing a bigger negative impact on stocks from the drought seen this summer outside the US. 
 
The EU Carbon Emission contract slumped by 30% following a near five-fold increase during the last year. The main reason behind the year-long rally was last year’s change in European regulations governing the availability of allowances. The idea behind the so-called Market Stability Reserve (MSR) mechanism for carbon allowances from 2019 was to drive up the price of carbon emissions and thereby force a move away from coal to cleaner fuels such as wind, solar, hydro, and not least gas. A power plant using coal must buy twice the amount of allowances as plants burning natural gas. 

The unintended result has been a huge speculative wave of buying which helped drive the price higher until reaching €25/ton, a 10-year high.  According to the Financial Times, the reason for the correction this week may have been triggered by comments from Poland’s energy minister calling for the EU to look at intervening in the market. Poland relies heavily on coal to power its utilities while a major consumer like Germany still produces close to 40% of its electricity from coal. 

The ECX Emission contract for December 2018 expiry dropped by 30% in just four days after reaching €25/t a ten-year high. The drop however did attract renewed demand after finding trendline support at $17.70/t.
 
Raw sugar’s three-week surge from a 10-year low at 10 cents/lb ran out of steam with traders booking profits. The rally has occurred amid increased signs of returning fundamental support challenging a near-record speculative short position. Support has been driven by crop concerns in Brazil, lower European exports following a drought-hit summer, and speculation that India may remove restrictions on sugarcane going towards ethanol instead of sugar production. A sharp drop in the open interest on the futures contract points towards a major reduction in the speculative fund short, which on September 4 stood at a near-record 18 million pounds. 

Brent crude oil once again reached but failed to breach the psychological $80/barrel level. The recent rally has been driven by multiple supply concerns; the main driver remains the US sanctions against Iran which have already started to have an impact on Tehran's ability to sell its crude abroad.

Together with Russia, Opec producers with spare capacity are unlikely to make up the shortfall from Iran. This development is driving the current overall bid in the market and the divergence in the shape of the WTI and Brent crude oil curves. While Brent has seen the front end of the curve flip from contango to backwardation (signalling a move from loose to tight supply) during the past month, WTI has only managed a general shift higher as the prompt price rallied.

This development helped drive Brent’s premium over WTI to $10/b before Hurricane Florence concerns halted any further widening.

The reason why crude oil has struggled to break higher is the underlying threat to future demand, particularly from EM economies that have seen a steep rise in the cost of fuel in local currency. This following a months-long dollar rally which saw the MSCI EM currency index drop by 8% since April.  

Monthly oil market reports from Opec, IEA, and EIA all highlighted a potential risk to demand but at the same time made no provisions in their 2019 outlooks for such an event. Instead they, just like the market, showed a growing concern for the short-term outlook for supply. The IEA wrote: “We are entering a very crucial period for the oil market. The situation in Venezuela could deteriorate even faster, strife could return to Libya and the 53 days to 4 November will reveal more decisions taken by countries and companies with respect to Iranian oil purchases”

Brent crude remains stuck in a low 70s to low 80s range with the short-term risk pointing towards a challenge of resistance between $80/b and $82/b as per the chart below.

Gold traded back above $1,200/oz but has yet to show enough strength to challenge resistance and with that, hedge funds bears who held a record short of 7.9 million ounces in the week to September 4. Having been continued sellers since May, ETF investors have yet to show any renewed appetite for gold. Despite having seen gold stabilise in recent weeks, total holdings have nevertheless dropped to 2,105 tons, a one-year low. 

Silver and platinum, meanwhile, have both yet to show any sign of renewed strength with their price relative to gold still hovering near multi-year lows. Traders will continue to look to the dollar for direction, and particularly to USDCNY as gold has maintained a high positive correlation to the Chinese currency of late. 

CNY, of course, remains a key indicator of developments on the trade war front. 

The US FOMC is poised to raise interest rates on September 26 and the market may continue to struggle ahead of this event. 

Gold has traded around $1,200/oz for the past five weeks as it continues to stabilise following the $200/oz sell-off between April and August. Those having sold gold have so far not had any reasons to worry and from a technical perspective the market needs to break above $1,220/oz – and more importantly $1,238/oz – for that outlook to change.