The almost synchronised commodity rally seen during the past few months continues to be challenged by an ongoing rise in US bond yields causing risk adversity and a stronger dollar. Metals of most colours, including copper, traded lower while Saudi Arabia’s push for higher prices helped drive crude oil to the highest level since last January.
The February 25 spike in US bond yields led to our warning in last week’s update that the commodity sector, led by precious metals, was facing a challenging period. Not due to a sudden change in the fundamental outlook which remains supportive across the commodity space, but more due to the risk that rising yields could trigger a period of deleveraging that may also expose the record speculative long held by hedge funds across energy, metals and agriculture.
An appearance from Fed Chair Powell on Thursday, one week after the first spike, failed to show sufficient concern about rising yields, even if Powell emphasised the intent to keep the policy rate low for now. The bond market threw another tantrum, sending US long-end yields to their highest daily close for the cycle. Risk sentiment cratered and equity markets went into a tailspin while the dollar found a fresh bid, thereby creating headwind for several dollar and rate-sensitive commodities, such as gold.
Copper, one of the darlings during the month-long commodity rally due to its tightening fundamentals and green transformation focus, suffered a rare week of losses. A few weeks back, the surge to a 10-year high was among others triggered by a Chinese whale accumulating a 1bn dollar copper bet in just four days. Developments like these, together with the forecast of rising deficits, helped drive a major build up in speculative positions on exchanges from New York to London and Shanghai.
A build-up which left the market exposed to a short-term change in the technical outlook. This past week we saw the result with High Grade Copper going straight through support at $4.04/lb and hitting $3.84/lb before recovering back above $4/lb. The unlikely but yet possible return to the uptrend from last March could take it down to $3.5/lb, corresponding with $7800 on LME Copper.
Crude oil jumped 5% after Opec+ decided to tighten the oil market further by deferring a planned production increase, basically gambling that US shale producers are more focused on dividends than increasing production. Thereby keeping speculators happy at the expense of the global consumer while adding further fuel to the risk of higher inflation.
In order to defend the 80% rally since early November, the group decided to roll over for one month the 0.5mn barrels/day that was up for discussion. In addition, Saudi Arabia extended its 1mn barrel/day cut, thereby risking overtightening the market as the global pandemic fades and mobility picks up. Several banks responded by raising their Q3 price forecasts towards the $75 to $80/b area and any short-term risk to oil is now primarily associated with the mentioned deleveraging risks spreading from other markets.
In defence of the group’s surprise decision to maintain production at current levels could also simply be that it’s the result of conflicting signals from the market. In the so-called paper market a rising backwardation in the Brent and WTI crude oil futures contracts have for weeks now been signalling market tightness. Part of this development being driven by speculative buying which tends to be concentrated in the front month contracts, the most liquid part of the curve.
However, the situation in the physical market looks a lot loser with traders saying there are plenty of cargoes available, especially for delivery to the top-importing region of Asia. Having seen and weighed the level of refinery demand for April, the group may have concluded that demand was not strong enough to raise production before May and beyond.
Gold dropped to a fresh nine-month low below $1,700 as the dollar strengthened in response to another Powell-led bond market tantrum after the Fed Chair refrained from pushing back against the recent surge in bond yields, especially real yields which together with the dollar remain two of the most important indicators driving the ebb and flow of demand for gold and precious metals in general. Silver meanwhile dropped even harder in response to the mentioned selling which has hit industrial metals such as copper and not least nickel, which has slumped 20% from its February peak.
From a longer-term bullish perspective, gold would need to hold above a major band of support between $1670 and $1690, while a break above $1765 would send a signal of renewed strength and support. Needless to say that gold is unlikely to catch a break until yields, and with that the dollar, stabilizes. Something that the Fed is currently not prepared to back, and which may result in more pain until financial conditions reach levels that forces the Fed’s hand to respond.
Ole S Hansen is head of commodity strategy at Saxo Bank.