Real yields a boon to tightening commodity markets
After what has already been a strong year for commodities, we maintain a bullish outlook into Q4 and beyond. The strong rally seen across many key commodities this year has been driven by surging consumer spending following the Covidled economic contraction — the biggest in living memory. As the impact of government spending and handouts from governments in Europe, China and the US begins to taper off, the market has started to cool a bit.
However, supply constraints will, in our opinion, continue to support prices despite a slower growth trajectory.
Ahead of the final quarter of 2021, the Bloomberg commodity index — which tracks a basket of major commodity futures evenly split across energy, metals and agriculture — had risen by 25 per cent, with gains seen across all sectors except precious metals.
Later in this outlook we take a look at the reasons why gold, the most interest rate and dollar–sensitive of all commodities, has struggled to rally despite what should have been strong tailwinds from nearrecord low negative real yields.
First though, we need to take a closer look at the European power and gas markets.
During September they surged to reach prices more than four times higher than the long-term average. At the time of writing Dutch gas — the European benchmark — was trading up 250 per cent on the year, while German power and coal prices were both up by around 150 per cent. These three markets, together with an also surging European emissions price, are not part of the mentioned index, which otherwise would have been higher than the ten-year high reached in September.
Surging gas and power prices have also been felt outside Europe with hot weather– related demand not being met by a similar response from producers. Add to this the worst quarter for wind power generation in years, and the pressure on traditional fuels such as gas and even coal has been elevated. As a result we are heading into the northern hemisphere winter with stock levels, both in the US and especially in Europe, well below the average seen in recent years.
If not arrested by a milder than normal winter or increased flows, either from LNG or from Russia through the soonto-open Nord Stream 2 pipeline, a bleak — and expensive — winter could await Europe’s consumers and energy-heavy industries.
ENGERGY: We see the Brent crude oil price range shift higher by $5 from the mid-60s to mid-70s that we forecast, and which prevailed throughout most of the third quarter. With crude oil settling into a range following the dramatic first half surge, the reflation trade also started to
deflate, thereby reducing investor appetite for commodities.
The fading momentum and return to rangebound trading helped drive a 23 per cent reduction in the combined net long futures position held by funds in WTI and Brent.
With more optimistic Covid-19 developments expected into the year-end, the IEA sees global oil demand rebound by 1.6 million barrels/day in October and continue to grow into the year end. Add to this the loss of more than 30 million barrels of production during the US hurricane season, along with the risk of failure to reach a nuclear deal with Iran, and the Opec+ group of producers are likely to continue to support a gradual price increase by keeping monthly production increases at a steady pace of around 400,000 barrels per day.
Just as the reflation trade deflated as oil settled into a range, the prospect for higher prices into the year end and beyond could be the trigger needed to re-establish that focus, thereby supporting reflation darlings such as copper, and potentially even gold.
Precious metals led by gold remain stuck in a range that by now has prevailed for more than a year.
Besides silver’s unsuccessful attempt to break above $30 during Q1, both metals have been stuck in ranges, with gold currently struggling to find a way out of its $200 wide range between $1700 and $1900.
During the past quarter one of the interesting developments was gold’s inability to shine despite a renewed drop in Treasury yields, not least ten-year real yields which at one point hit a record low at -1.2 per cent.
Gold’s inverse correlation with real interest rates has been well documented, and can be seen in the chart.
Along with the ebb and flow of the dollar and the general level of risk appetite, we have some of the key components which determine the direction of gold. With strong risk appetite being a constant throughout the year, at least up until August, gold’s value as a diversifier diminished.
SURGING GAS AND POWER PRICES HAVE ALSO BEEN FELT OUTSIDE EUROPE WITH HOT WEATHER– RELATED DEMAND NOT BEING MET BY A SIMILAR RESPONSE FROM PRODUCERS