The early January recovery across key commodities extended into a second week with the Bloomberg Commodity index rallying by more than 4 per cent since touching a near three-year low on the first trading day of year.
From an historical perspective we have often found that the initial direction financial markets take at the beginning of a new calendar year can end up being the wrong one. To avoid a turnaround, the market will be closely watching the current trade negotiations and whether China, the US and Europe manage to steer away from a looming economic slowdown.
Back to the current market, it has been the combination of renewed trade optimism, the US Federal Open Market Committee signalling its willingness to hold back on further rate hikes, combined with a weaker dollar, that have all helped support a major risk-on rally from stocks to high-yield corporate bonds and commodities.
We find that the recovery has been broad-based and primarily led by a strong recovery in crude oil. The safe-haven asset of gold which rallied strongly during December has despite the recovering sentiment elsewhere managed to hold onto its gains. Perhaps a sign that investors while returning to riskier assets are still buying protection against the risk of renewed weakness related to the continued shaky outlook for global economic growth.
The grains sector found support from the prospect of renewed Chinese buying of agricultural products. For soybeans however, the prospect of a bumper South American harvest hitting the market over the coming weeks could mean that a potential deal between China and the US may arrive too late to ensure a meaningful reduction in US stockpiles and with that, a recovery in the price.
Soft commodities, especially coffee and not least sugar, recovered strongly on a combination of a stronger Brazilian real, and specifically for sugar the prospect of increased cane-based ethanol demand (for fuel) continues its recovery.
Copper, while still range-bound, headed for its biggest weekly gain in two months on a combination of trade optimism, supportive Chinese economic policies, such as the recent announcement of a 1 per cent cut in the reserve requirement ratio (RRR) and not least the Chinese renminbi. The CNY has rallied to an almost six-month high at 6.74 against the dollar and in the process moved firmly away from the critical 7-dollar level which attracted a great deal of nervous attention back in Q4.
After finding support at $50/barrel last month, Brent crude oil has swiftly returned to the November-to-December consolidation area between $57.50/b and $64/b. Just like all other assets it’s the hopes of a deal between the US and China on trade which could reduce worries about the strength of demand going forward. Adding to this, the weaker dollar and not least ongoing production cuts from the Opec+ group, which should further reduce supply over the coming months.
A trade deal between the US and China, however, is likely to slow but unlikely to reverse the deterioration seen recently in forward-looking economic data from the US to Europe and China. On that basis the upside at this stage may be limited and it could lead to slowing upside momentum as we approach the upper area of the above-mentioned consolidation zone for Brent at $64/b and WTI at $55/b.
Please note that due to the US government shutdown the CFTC has not issued any Commitments of Traders reports since the week of December 18. The COT report provides an important weekly insight into the size and direction of positions held by hedge funds across key futures markets from currencies to bonds and not least commodities.
The ICE Futures Europe Exchange, however, continues as normal with Brent crude and gas oil data still being published. In the week to December 31 when Brent touched $50/b, hedge funds cut bullish Brent crude oil bets by 10,000 lots to 152,000 lots, a 70 per cent reduction since October when the sell-off began.
The recovery across riskier assets failed to deliver a blow to gold, which after reaching $1,300/oz and after rallying by more than 100 dollars since November, was overdue a correction. However, despite surging stocks and rising bond yields, gold continued to attract demand with buyers on several days emerging ahead of $1,280/oz.
The recent dollar weakness, not least against the CNY, has provided a bulwark against the negative impact of surging stocks and rising bond yields. A potential US-China trade deal may give global risk sentiment a further boost but with global growth momentum slowing investors remain cautious and still on the lookout for ways to protect themselves against renewed weakness.
On that basis and with the Fed on pause amid increased economy and policy uncertainty we maintain a bullish outlook for gold.
As noted, due to the US government shutdown data covering speculative positions held by hedge funds has not been available since December 18. During this time however, we have seen a continued rise of holdings in gold-backed ETFs. During the past week total holdings compiled by Bloomberg climbed to 2,234 metric tonnes. Just 5.5 tonnes shy of the recent peak from last May, which was the highest in more than five years.
[By Ole Hansen – Head of Commodity Strategy at Saxo Bank]