Commodities confronted with new headwinds as credit default swaps surge
Global commodities
At the beginning of the year, the core to our 2023 commodities outlook was driven by a cooling US economy, a resurgent China and a recovering Europe (see here). These are idyllic conditions for a commodities rally as a slowing US would allow for a Fed pause, leading to a weaker US dollar and offering the space for stronger Chinese fundamentals to dominate commodity pricing to the upside. While commodities were initially resilient into 2023, iffy global macro conditions has been a sticking point in paper commodity markets in H1 2023, with short sellers continuing to amass positions betting on a heavily-cyclical asset like commodities to slump. Moreover, the erosion of risk premium has also influenced the curve structure across a number of commodity markets, and the extent of inversion across futures curves has declined, reducing the added benefit of strongly positive roll yields observed in 2022 amid supply-side constraints. Against this bearish backdrop, we ask the question of what it could take for investors to turn more constructive on commodities in H2 2023? In our view, a risk reversal must come from an easing in tightening conditions and should the Fed signal the start of its easing cycle, then our conviction is that the physical market tightness will spread into the world of paper market contracts, flushing out speculators and propelling commodity prices higher (see here).
Energy
Glance at oil prices and you would not know that two of the largest producers – Saudi Arabia and Russia – pledged to continue curbing output this week. These cuts, which are from the core members of OPEC+, accentuate coherence and consistency within the alliance, whilst equally being precautionary and proactive, in our view. This does not translate – or should be read by the market as OPEC+ cutting to offset a prevailing weak demand outlook – but rather, it aims to mitigate downside volatility in the oil price by solidifying a price floor. Meanwhile, Asia’s LNG (Japan-Korea JKM) prices may fall towards single digits as autumn approaches with China turning to coal and South Korea to nuclear power generation for the winter months ahead.
Base metals
Base metals enter the summer lull on the back foot with Chinese manufacturing subdued, European PMIs flashing warning signs and threats from a stronger US dollar are intensifying. The PMI (ex. China) surveys indicate a more significant and long-lasting inventory adjustment in manufacturing is continuing which remains a rigid headwind for base metals demand and prices.
Precious metals
Gold remains down from record May levels, owing to the confluence of (i) the resolution to the debt ceiling crisis, (ii) calming in the banking sector, and (iii) the Fed’s prolonging of the tightening cycle in order to combat inflation. Gold is historically sensitive to real rates, and while there has been a significant disconnect in this relationship, we anticipate real rates to weigh on gold prices somewhat, but will likely be more than offset by unprecedented EM central bank demand for bullion.
Bulk commodities
China’s vast steel industry has sent a red flag alert on how challenging H1 2023 has been and how grim H2 2023 may turn out to be. A group of prominent mills warned that the industry faces a difficult run to the end of 2023 as consumption disappoints, profitability lags and pressure to cut costs mounts. Their rhetoric signals that steel production run-rates could be reduced further.
Agriculture
Corn prices have fallen to the lowest since February 2021 as larger-than-expected US acreage and improving crop conditions signals ample supplies. Whilst this is a welcome step towards stabilising the market, following the drought in the earlier part of the season, we are a long way in determining if 2023 production prospects can be saved.
Core indicators
Price performance and forecasts, flows, market positioning, timespreads, futures, inventories, storage and products performance are covered in the report.
