By Ole Hansen, Head of Commodity Strategy at Saxo Bank

Dubai, UAE, March 24, 2019:  Commodities traded higher for a second week, albeit at a slower pace, with gains being driven by precious metals and – for a change – the agriculture sector. Precious metals received a boost from a sharp drop in bond yields after the US Federal Reserve signalled no further rate hikes this year while also slowing its balance sheet reduction. 

The dollar initially dumped on the news before once again being pumped higher on Friday when dismal PMI data from both Germany and France provided some renewed support for the greenback. Stocks, and with that the general level of risk appetite, initially rose before pausing in response to ongoing concerns about the outlook for economic growth. 

The energy sector saw WTI and Brent crude oil both attempt to move higher amidst tightening supply from the Opec+ group of producers. In the process, they both recouped half their October-December losses before pausing around $60 and $70/barrel, respectively. A big, counter-seasonal drop of 10 million barrels in US crude stocks supported a narrowing in the spread between the two global oil benchmarks. 

The industrial metals index, led by zinc, reached a 24-week high before growth concerns and the reversal in the dollar created a technical signal that could lead to a deeper correction over the coming weeks. Not least Dr. Copper which dropped to a one-month low in response to a sharp decline in German manufacturing activity. 
 
The Bloomberg Commodity Agriculture sub-index, which recently hit a record low, rose for a second week. Weather related disruptions in the US supported grains while the swine fever outbreak in China has led to surging demand for US supplies. 

Momentum-chasing money managers had until March 12 accumulated a record short position across 14 major agriculture commodities of more than 600,000 lots. With the fundamental outlook beginning to improve, these positions are now being scaled back and as a result we could see the sector continuing to climb higher over the coming period. Focus on the most shorted commodities which are soybeans, corn, wheat and cotton. 
 
Another sector which has seen prices come under pressure in recent months has been global gas prices. Apart from a milder than normal winter in Europe and Asia and bulging stocks, it is the continued rise in US exports of Liquified Natural Gas that has supported a steep drop in gas prices in both Europe and Asia this past winter. US LNG has flooded Europe since October last year when ample stocks in Asia led to cargoes being diverted to Europe instead. 

Russian gas giant Gazprom, which up until now had dismissed concerns about US LNG taking market share, has felt the impact to such an extent that it now says US exports have become their biggest competitor (Source: Reuters). 

Converted to USD/therm for comparison reasons, Dutch gas (TTF), the European benchmark, has dropped to a near two-year low at $4.8/MMBtu. In Asia, the LNG Japan/Korea (Platts) benchmark that traded above $11/MMBtu last October has since more than halved to the current $4.7/MMBtu. The sell-off, however, is likely to pause sooner rather than later as US producers will increasingly be out of pocket when adding the costs of liquefaction, shipments and regasification back to natural gas.

 The Opec+ group of producers’ recent meeting in Baku, Azerbaijan, left the market with the clear impression that crude oil will continue to climb higher. Several Opec producers, not least Saudi Arabia, need oil back above $80/b to meet their fiscal obligations and they are unlikely to be satisfied with Brent crude oil below $70/b. 

On that basis the market now expects that supply will be kept tight beyond June to support further price appreciations. This is a strategy that would work well into a world of strong growth and demand but potentially not into one that is seeing the US yield curve continuing to flatten and where recession risks have risen to the highest since 2008. While Opec, together with Russia, can control output, it has no influence on demand, and as the price of oil goes up so does the tax burden on everyone else. 

In addition, we note that despite all the almost one-sided supportive news flow in recent weeks and months, the combined net-long in Brent and WTI has only reached 450k lots, well below the 830k we saw last October before the price collapse. This is probably due to a certain reluctance from macroeconomic funds to go all-in when the recessionary clouds on the economic horizon seems to be getting darker.

Based on these observations, we see further upside to oil into Q2 but for now adopt a short-term bearish stance in the belief that $60/b (WTI) and $70/b (Brent) will present temporary lines in the sand. The well-being of the stock market will send an important signal as to whether demand growth concerns will re-emerge as a focus to offset the price supportive focus on (falling) supply.

The dramatic turnaround seen during the past few months by the Fed is seen as bullish for gold as the return to a dovish stance highlights the risk of a gold-supportive recession within the next 12 months. The immediate future, however, may not yet provide the spark gold needs to break strong resistance. We do, however, expect that a formidable challenge can be mounted later this year in response to a weaker dollar, stable to lower bond yields and concerns about global stocks’ ability to forge higher amid raised growth concerns.

If you are bullish gold, then, consider silver: it remains the forgotten metal trading 12% below its five-year average relative to gold. Another is platinum, which should be supported by its historic +700-dollar discount to palladium and +400-dollar discount to gold

As we have often mentioned, we need to keep in mind that many investors buy gold to own an insurance policy against adverse movements across other investments such as stocks. On that basis it is worth keeping a close eye on flows in and out of exchange-traded products which are often used by long-term investors. As long equity markets continue to show the current resilience, gold is unlikely to mount a strong enough challenge at the massive area of resistance between $1,360 and $1,380. 

Support, meanwhile, remains unchanged with $1,275/oz being the major line ahead of the 200-day moving average at $1,247/oz.