Metals dented as rising bond yields add pressure

Ole Hansen -

The Bloomberg commodity index traded close to unchanged during the week, with losses in energy and metals offset by a strong rally in agriculture commodities.

Rising bond yields in response to recent hawkish central bank communication hurt precious metals from the prospect of rising opportunity costs and industrial metals due to growth concerns as the price of money begins to rise.

Despite a supportive weekly US inventory report, crude oil succumbed to renewed selling after a short-covering rally which lifted the price 12 per cent off its recent floor.

Opec’s failure to cap production due to increases from Nigeria and Libya — both exempt from cutting production — has left the market with the view that the only thing that can reduce inventories is to push the price low enough to impact production growth among high-cost producers, especially in the US.

Grain prices, especially soybeans and not least wheat, surged after the US Department of Agriculture downgraded the planted acreage estimate for both crops.

Hot and dry weather conditions had already triggered major gains in wheat as the proportion of the growing crop rated good or excellent slumped to a 30-year low at just 37 per cent. With global stocks of wheat still expected to remain elevated after excess production in previous years, some profit-taking emerged on signs that the high prices risked reducing the appeal of US crops on the export market.

The Bloomberg precious metals index hit a five-month low this week as rising bond yields continued to add pressure.

The main catalyst for the recent weakness has been the hawkish tilt adopted by the European Central Bank and Bank of England last week.

Together with the US Federal Reserve, which has been tightening since December 2015, the addition of these two central banks turning hawkish helped send bond yields sharply higher.

Silver turned negative on the year, while gold witnessed a bull-and-bear fight close to the May low at $1,215/oz, with support coming from increased event risks, such as North Korea, US-China tensions,G-20 meeting, the Qatar diplomatic situation and weakness in major tech stocks.

These geopolitical developments have countered the ongoing macroeconomic pressures and helped attract demand from investors looking for diversification.

US 10-year real yields reached a new high for the year, while the Japanese yen continued to weaken despite general dollar weakness as the Bank of Japan stuck with its policy of keeping bond yields suppressed.

While gold has been tracking the yen and therefore remained range-bound for the past few months, a surging euro has seen XAUEUR drop to a 14-month low.

The heightened risk of monetary tightening beginning to deprive the market of liquidity has also raised concerns about a correction in the stock market.

Currently the focus is centred on the very liquid technology stocks, including Facebook, Apple, Amazon, Microsoft and Google, which combined account for more than 60 per cent of the Nasdaq market cap.

Silver broke its May low, and the weakness extended further after another unfortunate “flash crash” on Friday during the early Asian session.

As a result, the gold-silver ratio has become increasingly stretched as it reached a 14-month high above 77.

Another solid US job report combined with further silver weakness has raised the risk of gold testing below $1,214/oz.

A break could signal a move towards the next key area of support at $1,189/oz, the 61.8 per cent retracement of the December-to-June rally.

Big oil swings recently show not only that the third-quarter bull/bear fight is heating up, but also that the summer holiday is beginning to affect liquidity, thereby raising the risk of larger price swings.

Despite trading almost unchanged compared with three weeks ago, WTI oil has nevertheless moved around by more than $9 during this time (using daily close). Having just witnessed a 12 per cent rally driven by short-covering, oil turned lower once again on news that Opec’s production had reached a new high for the year in June.

Production news remains a key driver, with a second weekly reduction in US inventories of oil and products having a limited positive impact.

With Opec failing to lower production as Libya and Nigeria — exempt from cutting —continue to ramp up output, the oil price could be forced to reach a level where US high-cost producers refrain from increasing production further.

The weekly petroleum status report from the US Energy Information Administration showed the biggest drop in US commercial oil and fuel stocks since last September.

A weekly — temporary — decline in oil production the previous week was reversed, generating some negative headlines.

It is, however, worth noting that according to these weekly estimates US crude oil production has remained flat for the past five weeks.

After rising strongly by 439,000 b/d during the first quarter, it slowed to 139,000 b/d in the second.

The weekly rig count showed the first decline in 24 weeks last week, but several more updates are needed to see if the price slump during the past few months has started to affect activity.

Lower lows and lower highs continue to attract short-selling, and with Opec currently unable to bring down production, the price of Brent crude oil is likely to remain stuck below $50/b for the time being.

[Ole Hansen is Head of Commodity Strategy at Saxo Bank]