By Ole Hansen, Head of Commodity Strategy at Saxo Bank

United Arab Emirates,  September 27, 2020:  Commodities traded lower with the stronger dollar and reduced inflation worries delivering a blow to the sector. Precious metals led by silver took the biggest hit while coppers strong momentum since March also faded. Grain traders took profit as the strong dollar reduced export demand. Crude oil held up very well despite worries about demand and the risk of rising supply.

Commodities , traded lower during the week where the stronger dollar left many markets bruised. The Bloomberg Commodity Index, which tracks a basket of major commodities spread evenly across energy, metals and agriculture, traded lower by 3.2% with energy, due to strong gains in natural gas, being the only sector strong enough to put up a fight against the adverse impact of the stronger dollar.
The dollar rose to a two month-high against the euro as risk adversity returned. This was in response to a continued rise in coronavirus cases around the world together with infighting in Washington raising doubts about Congress’ ability to push through another stimulus package. The negative dollar view that had been growing in recent months had particularly, according to speculative positions in the futures market, been expressed through a near-record euro long.

The break below €1.1700 therefore created some nervousness about a deeper correction which hurt markets with an elevated bullish positioning in particular, such as precious and industrial metals. Silver slumped and has now already clocked up two +20% corrections since almost hitting $30/oz just six weeks ago. Wild swings like these have left a trail of battered investors, thereby raising some doubts about the metal’s ability to move higher.
 
A month long rally in the grain market ran out of steam as the stronger dollar and signs of slowing Chinese demand raised questions about how much further soybeans and corn can rally at this stage. Speculators hold the biggest combined long for this time of year since 2013 in wheat, corn and soybeans. As the harvest season gather pace without any major hiccups, they could now potentially be forced to cut back on their exposure. Soybeans which has been the biggest climber on strong Chinese demand headed for its biggest weekly drop in six months as the price above $10/bu saw overseas buyers turn to Brazil instead.

While the dollar has yet to show signs of topping out, sentiment did try to improve ahead of the weekend. Despite the stand-off over Trump’s plans to nominate a replacement for the Supreme Court in the last weeks before what could become an ugly election, Democrats, caught on the backfoot by Trump’s recovery in the polls, are drawing up plans for a new but relatively small $2.4 trillion stimulus and Trump’s Secretary of Treasury Mnuchin made positive comments on the prospects for negotiations. 

Gold dropped below $1900/oz but managed to find support ahead of key support at $1837/oz, the 38.2% retracement of the March to August rally. Silver, which as mentioned recorded its second bear market (a 20% movement from the recent peak), saw its relative value against gold tank to a near two-month low.

In the short-term, both metals will be facing some headwinds from the recent drop in inflation expectations leading to rising real yields as well as the strong dollar and the recent high correlation with stocks, which may cause it to continue to trade nervously ahead of the November U.S. election.

It does highlight how markets across different asset classes continue to show a high level of correlation. Given the latest price movements it is very clear to see what power the dollar holds over the market with regards to overall level of risk appetite. It is therefore probably not surprising to find that several different markets from the S&P 500 and AUDUSD to gold, oil and coffee all managed to find support and attempted a bounce from their 100-day moving average.

Another casualty of the renewed dollar strength and with that lower risk appetite was copper. The white metal’s impressive recovery from the March low had already started to slow with the price of HG copper struggling to extend its gains beyond $3.1/lb. The rally seen across industrial metals, not least copper, in recent months has been driven by a post-pandemic recovery in Chinese demand supported by credit and scattered supply disruptions.

While the fundamental outlook remains supportive, the lack of fresh upward catalysts and an elevated net-long position held by speculators such as hedge funds and CTAs helped drive a correction to $2.91/lb this past week. Depending on the resilience among speculators and developments elsewhere, the price correction can potentially extend further towards the early August low at $2.77/lb.

Despite several headwinds, crude oil managed to avoid the selling seen across other commodities. While down on the week, it still managed to put up a defence despite doubts about the rebound in demand with lockdown measures on the rise, together with the risk of rising supply and the stronger dollar. All perhaps signs that the market had taken note of the strong verbal intervention given by the Saudi Energy Minister Prince Abdulaziz bin Salman. At the recent OPEC+ meeting he condemned members that tried to get away with pumping too much crude while also challenging short sellers in the futures market who in the week to September 11 held a combine 250 million barrel short in WTI and Brent crude oil.

Additional support came from an across the board weekly drop in U.S. crude oil and product stocks and a monthly survey from the Dallas Fed in which they asked 160 executives from the oil and gas firms questions about the current state of the market. Some 66% replied that U.S. production had already peaked, and the vast majority needed a WTI price above $50/b in order to substantially increase the U.S. oil rig count. On that basis, with the current lack of progress towards higher prices, we may see a further drop in U.S. oil production over the coming months.

Lower U.S. production and elevated stock levels around the world have supported a reduction in WTI’s discount to Brent to less than two dollars per barrel. Overall, however, we remain skeptical about crude oil’s short-term ability to move higher and as per the chart below Brent crude is currently stuck in a range between $39.50/b to the downside, while resistance is at $43.60/b where both the 50 and 200-day moving averages meet.