- Bloomberg Commodity index gained for the first time in six weeks
- USD weakened as central bankers turned hawkish
- Weather supported crops in the US, and wheat was the high-flier of the week
- Weeks of selling have cut fund exposure in 23 commodities by 70% from record
- Several markets, including coffee, sugar and oil, exposed to short-covering rally
The high-flier of the week was wheat, not least the red spring wheat used
in bagels, high-quality breads and cereals. Photo: Shutterstock
By Ole Hansen
The Bloomberg Commodity index rose for the first time in six weeks, with gains across most sectors except precious metals. The US dollar weakened by the most in six weeks as central bankers turned more hawkish, weather worries supported crops in the US, and a surprise, albeit temporary, drop in US oil production helped trigger a short-covering rally in oil and fuels.
Precious metals struggled amid rising bond yields as it became clear that financial stability, the so-called third mandate (more than consumer inflation), is now the policy focus among central bankers. The weaker dollar primarily resulted in euro strength instead of yen strength (to which gold has a stronger positive correlation).
HG Copper moved towards the higher end of its 2017 range. Improved China factory data could see demand improve, while falling inventories have also lent support this week. Inventories monitored by exchanges in Shanghai and London dropped to the lowest level since the first quarter. However a band of resistance between $2.75/lb and $2.80/lb is unlikely to be breached at this stage given the lack of momentum.
Many weeks of selling have cut the hedge fund exposure in 23 major commodities by 70% from a record high to a 15-month low. With short-selling picking up during this time, several markets, including coffee, sugar and not least oil, were left exposed to a short-covering rally. The net-long position held by funds in five major oil and fuel futures has fallen by close to 750 million barrels since the February record.
The high-flier of the week was wheat, not least red spring wheat traded on the Minneapolis grain exchange (MGEX). Hard red spring wheat is one of the highest-protein varieties grown and is sought by millers because of its high quality. It is found in bagels, high-quality breads and cereals.
In June, the price of red spring wheat has jumped by a third as dry weather across the northern US has created the worst crop conditions since 1988. Grain positions were also adjusted ahead of important stock and acreage reports from the US Department of Agriculture late Friday.
One of the major developments of the week was increased warnings on the global debt bubble from the Bank for International Settlements (the so-called "central bank of central banks"). Asset prices from bonds to stocks and the dollar took note as several central bankers turned more hawkish, with the policy focus apparently turning to financial stability, the so-called third mandate (more than consumer inflation).
Precious metals struggled amid this change among central bankers as it helped send bond yields higher. While a weaker dollar is ordinarily supportive of gold, USD's softness was mainly versus the euro rather than the yen, and EUR is less positively correlated to gold than is JPY, which was down on the week. Renewed stock market weakness, however, helped cushion the fall with investors anxious about a major correction, continuing to look for diversification.
The current hedge fund net long in futures and options stood at 105,000 lots in the week to June 20. This is in line with the five-year average for this time of year and shows a market where positioning is relatively light, not least compared with this time last year when the net long hit a record high at 287,000 lots.
Gold is currently trading within a range established during this past quarter. The latest weakness— caused by a possible rogue trade last Monday — was halted at the 200-day moving average ($1,236/oz), well ahead of the critical support at $1,214/oz.
Above this level, which is the May low, we maintain a constructive view on gold.
At this stage, however, and following two failed attempts to break higher above $1,300/oz, the market needs a boost to make a third and more successful attempt. In our opinion, such an attempt would require additional stock market weakness and continued investor focus on diversification.
Gold price - XAUUSD
Source: Saxo Bank
The extended oil battle between supply, demand, and inventories continues, with short-sellers recently gaining the upper hand. Traders desperate for hard data, however, reacted positively to the first bullish weekly US inventory report in four weeks. Falling gasoline inventories and a surprise but temporary 100,000 barrels/day reduction in production helped trigger additional short-covering, and the weaker dollar also provided some support.
While sentiment in the oil market has been turning increasingly bearish during the past couple of months, we understand the reasons for this sentiment, but we are also seeing potential changes on the horizon which could help stabilise and potentially send the market higher.
- US oil production growth has reduced the need for Opec's oil, but current low prices, if maintained, are likely to affect 2018 growth forecasts as hedging activity slows with some producers unable or unprepared to keep up production at current low prices.
- US oil production has risen by more than 500,000 b/d year-to-date, but less than 100,000 barrels of that growth occurred during the second quarter when the price began to weaken.
- Rising production from Libya and Nigeria has presented an additional headache, but the low hanging fruit has almost been harvested, thereby reducing the risk of a further rapid increase.
- During the third quarter, Opec’s ability to maintain exports should be tempered by the need to keep more oil at home to meet peak summer demand.
- The Qatar spat risks breaking the Opec agreement, but the deteriorating relationship between Saudi Arabia and Iran presents upside risks.
- Bullish fund bets have been cut by 562,000 lots, or 60%, from February record, and with gross shorts rising strongly, the risk of a short covering squeeze has risen.
WTI crude oil has made a tentative recovery after hitting a technical target at $42/b last week, the 100% extension of the April-to-May selloff. Most of the recovery seen so far has been driven by short-covering after the latest COT data from June 20 showed a major pick-up in short-selling.
With the changed sentiment in recent days, a break above $45.85/b — the 38.2% retracement of the May-to-June selloff — is likely to accelerate short-covering as above this level the rally becomes more than just a weak correction within a downtrend. The previous two lows in March and May triggered 14% and 19% rallies, primarily due to short positions being scaled back.
Source: Saxo Bank
— Edited by John Acher
Ole Hansen is head of commodity strategy at Saxo Bank