By Ole Hansen
August turned out to be the strongest month for the broadly-exposed Bloomberg Commodity Index, since April 2016. Four consecutive months of gains have seen the index claw back most of the pandemic-driven collapse back in February and March.
An unprecedented amount of central bank stimulus, rock-bottom US and global interest rates, recent dollar weakness, weather worries and demand for inflation hedges are all seen as key reasons behind the current rally.
All the major sectors traded higher on the month, with natural gas, silver, corn and RBOB gasoline leading from the front. Gold, which finished July near a record high, is one of the few recording a small loss on the month. The final week of the month saw the grain sector, which up until recently was the most shorted by speculators, record strong gains. Adverse weather in the US and elsewhere has led to a downgrade of yield forecasts while strong Chinese buying of corn and soybeans has supported the demand side.
Industrial metals also had a strong finish to the month with tight supplies in some markets, unprecedented stimulus and US interest rates stuck at zero providing the support. Adding to this, economic data surprises from major consumers such as China and the US.
Crude oil and especially fuel products rose ahead of Hurricane Laura slamming into the Texas/Louisiana coastline on Thursday. This was, however, quickly followed by a price correction after the hurricane narrowly missed the region’s key energy infrastructure. With two more storms currently on route across the Atlantic bowling alley, a much needed crude oil correction is unlikely to emerge at this stage.
US Fed Chair Powell unveiled the conclusion of the Fed’s long-term policy review. In it, he declared that the Fed is now running with a “flexible average inflation targeting” regime, really nothing new relative to expectations, and the lack of explicit levels and of any opinion on the desirability of yield-curve control policy meant that this speech, and the Fed’s conclusions, were well-flagged and offered nothing new. Perhaps Fed Chair Powell was reluctant to egg on financial markets, which are looking frothy here, especially the technology-heavy Nasdaq which continues to make new record highs.
From a gold and silver perspective, the speech in our opinion did nothing to alter our positive outlook. Higher inflation tolerance with the Fed seeking an average inflation of 2% could see interest rates stay low for the next five years. In the short-term, no mention of yield-curve control saw US ten-year nominal yields move higher, thereby potentially reducing the appeal for precious metals. Key, however, remains developments in real and breakeven yields. As long as real yields remain anchored around –1% while inflation expectations (break evens) move higher, gold should be able to withstand a potential steeper yield curve.
The biggest short-term risk to gold remains the emergence of a workable and widely distributed vaccine, together with a sharp correction in stocks leading to gold liquidation from investors in order to raise cash in hurry.
Having found support earlier in the week at $1900/oz, the market is still in range-bound mode with $2015/oz the big level that needs to break in order to attract fresh technical buying that could trigger a resumption of the rally.
Crude oil remains range-bound following another hurricane scare that briefly saw the market test the upper bounds of the current range. Crude oil and gasoline both reached five-month highs as the focus temporarily moved from the pandemic impact on demand versus Opec+ production cuts to the US Gulf coast. At the end of the week, the sector could breathe a sigh of relief after the hurricane missed key energy assets, especially the world’s biggest concentration of refineries.
What now follows will be several weeks of disruption to imports and exports of oil, fuel and natural gas, as well as production and refining activity. These disruptions will be visible in the “Weekly Petroleum Status Report” published on Wednesdays by the US Energy Information Administration.
WTI crude oil struggled to find a bid as production shut-ins from oil rigs in the Gulf of Mexico were more than off-set by lower demand from refineries and a halt to exports. It highlights, and in our opinion supports, the view that crude oil may struggle, at least in the short-term to rally much further. While fuel demand in the US continues to recover, the pandemic is currently gathering momentum across Asia and Europe. And while renewed lockdowns are unlikely, the impact on fuel demand is being felt. At the same time, Opec+ are struggling to reign in more than 2mn barrels/day from countries that have yet to reach agreed production targets.
A break below $43/b may increase the risk of long liquidation taking the price lower towards $41/b and potentially as low as $38.5/b, the July 30 low. As mentioned, the potential hurricane threat from two storms currently building in the Atlantic may, at this stage, limit the downside risk. Brent crude oil, meanwhile, has yet to break out of its narrowing range, currently defined to the downside by the 50-day moving average at $43.75/b and to the upside by the 200-day at $45.80/b.
Commodity investments can be done through exchange-traded funds. There are several options but if the view is to achieve broad exposure to commodities for the reasons mentioned at the top, there are several ETF’s fulfilling that purpose. Some homework, however needs to be carried out with regard to the kind of underlying exposure these ETF’s have to invidual commodities and sectors.
Three of the major ETF’s providing a broad exposure to commodities as well as their individual sector exposures are shown below. A strong year so far for metals and weakness in energy have resulted in a relative better performance in the two ETF’s that carry the lowest exposure to energy and highest to metals. Please remember that local restrictions may apply as to which ETF’s are best suitable.
* Ole Hansen is head of commodity strategy at Saxo Bank.
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