Commodities : Strong month despite late decline in crude and fuel

By Ole Hansen, Head of Commodity Strategy at Saxo

Despite an end of month wobble, the Bloomberg Commodity Total Return index was heading for a third monthly gain with all sectors except energy making positive contributions, highlighting an asset class that increasingly has been firing on all cylinders, read sectors, amid the outlook for tightening supply supporting key commodities from copper, aluminium and silver to several food commodities from cocoa, coffee and now also wheat. Meanwhile, a succession of fresh record highs in gold has yet to deter demand from central banks and investors around the world, seeking a hedge against sticky inflation, a rising global debt pile and multiple geopolitical uncertainties.

Gas and oil

US and especially EU gas prices jumped with the Dutch TTF benchmark hitting a year high in response to unplanned outages in Norway, renewed concerns about the remaining supplies from Russia, and not least the prospect for increased competition for LNG from Asia where extreme weather is putting pressure on Asian power markets. Staying with energy, Brent trades down around 4% on the month, near key psychological support at USD 80, and it has now lost more than half the strong gains seen between December and early April. A recent weakness in refinery margins and weaker time spreads in both WTI and Brent suggesting oil demand has hit a soft patch following a strong first quarter.

However, despite the current softness we still see demand picking up in the coming months amid seasonal strong demand in the Middle East and Asia towards cooling, as well as the US summer holiday driving season, and strong demand for jet fuel. All eyes now on the 2 June OPEC+ meeting and how the group will respond to prices trading close to USD 80 instead of USD 90, a price level preferred by most members.

We view the 75-dollar in Brent as a major line in the sand below which OPEC+ would likely step up their efforts to support prices, especially considering an outlook for global demand growth rising above trend this year. With that in mind, it would not be a surprise should the group signal an extension of the current cuts until year-end, in the belief that demand will recover before then.

Setback for copper

Copper suffered a sharp setback after the recent surge to record highs in London and New York further deterred demand from physical buyers. Not least in China, the world’s top consumer of copper, where data for weeks has been telling a story about demand softness that financial traders thoroughly ignored amid the bullish price momentum, and the long-term focus on supply struggling to meet strong demand towards the electrification of the world. Recently the mentioning of AI and an anticipated demand for power to run a growing number of data centres supporting AI helped attract new investors into copper, some perhaps not fully understanding how commodities work.

Commodities are spot products where the price is determined by the prevailing balance between supply and demand, not what that balance may look like in six or twelve months’ time. The recent copper squeeze in the High Grade Copper future traded in New York occurred after physical traders sold into a rising premium between the High Grade copper price in New York and the LME price in London. However, as the spread due to speculative demand for HG futures continued to dislocate, short sellers were eventually forced to buy back their short positions, thereby triggering a dislocation which is only now getting worked back to normal levels.

The break below USD 4.75 per pound on the High Grade contract signals a short-term loss of momentum potentially leading to a period of consolidation while speculators adjust elevated long positions, both in London and New York, and the focus returns to current fundamental developments, not least in China where copper stocks monitored by the Shanghai Futures Exchange continue a counter-seasonal rise, hitting 322,000 tons, well above the 130,000 tons seasonal average. A development that signals ample supply while challenging the bullish conviction held by traders and investors who - rightfully in our opinion – expect higher prices in the future.

Precious metals: spotlight on silver

In precious metals, the spotlight has shone the strongest on silver this past month, especially following its technical breakout above USD 30, a level that had offered resistance on several occasions since 2020, and now support. Gold meanwhile shows signs of settling into a wide range while awaiting further clues regarding the timing and depth of US rate cuts, currently reduced to just one this year, and not until December after the US Presidential election.

Silver’s credentials as a semi-industrial metal have served it very well during the past month when gold extended its gains to fresh record while copper led the industrial metal sector higher. From an investment perspective, silver trades well below its USD 50 record from April 2011, and as such is an easier choice for some than gold which continues to reach fresh record highs. Increased demand for copper in the coming years from the electrification of the world and worries about mining companies being able to meet that demand growth has driven copper to a record high this month before temporarily in our opinion hitting the buffer.

Looking at silver some of the same supply / demand dynamics can be seen, adding an additional layer of support. Most recently the price, as mentioned, finally broke above USD 30, and it helped trigger fresh buying from momentum-focused traders. Geopolitics play a minor role when it comes to silver as opposed to gold where central banks in order to de-dollarize their reserves have been hoovering up gold in record amounts since Russia invaded Ukraine, an action that led to the freezing of Russia’s assets abroad.

Silver tends to be more volatile than gold and its relation can be traded through the gold-silver ratio which recently slumped to an August 2021 low at 72.70 ounces of silver to one ounce of gold, down from a January high above 92. It shows that while silver most of the time travels in the same direction as gold, it often happens at a much faster pace, both up and down. The biggest short-term risk to silver is a change in the technical and/or fundamental outlook which may trigger aggressive long liquidation from speculators.

Grains: weather worries

The grains sector remains on track to record a 6.5% gain this month, thereby extending a succession of monthly gains to three, with gains being driven primarily by surging wheat prices in Chicago and Paris. Both rallying strongly since hitting a multi-year low back in March. That low point concluded an almost two-year decline that saw prices fall by close to 60% from a record high, reached in May 2022 following the Russian invasion of Ukraine.

While the price declines seen during this time were triggered by two good harvest years, not least in Russia, the world’s top exporter, the recent bounce has been driven by fresh weather concerns, not only in Russia but also in key production regions in Europe and Ukraine which is heading for its driest May on record.

The biggest boost to prices has been led by a dramatic downgrade to the production outlook in Russia where drought and frost have reduced this year’s crop from an estimated 93 million tons last month to 82 million tons currently. To put this into perspective, Egypt one of the world’s top buyers of wheat last year imported around 11 million tons, so in just one month the production outlook in Russia has been lowered by that number.

Weather maps covering southern Russia and Ukraine will be watched closely in the coming weeks for signs of an improvement, but so far they still point to dryness. It is however still too early to sound the alarm bells given the current outlook for a good crop season in the US, and a potential improvement in Russia, but overall global stock levels of wheat may fall to a nine-year low in the coming season, and it highlights how increasingly volatile weather developments may impact the production of key food commodities from wheat, coffee, cocoa, olive oil and orange juice.

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