Commodity market focus: DM weakness versus EM strength

With no clear solution to the Ukraine war in sight, the Fragmentation Game, the title of this Quarterly Outlook, is very much being felt across the commodity market as well. Most acute perhaps is the energy sector, where sanctions against Russia have created a two or even a three-tier energy market, leading to a major change in global supply routes. The consequence is one of longer shipping routes and longer time spent at sea, adding upward pressure on shipping capacity and costs. For example, Russian crude and fuel exports from the Baltics, the bulk of which used to go to Rotterdam, now must find buyers much further afield in the Middle East, India, China and even South America. 

Precious metals look for peak rates to support the next move up

Gold and silver upside remains and following a first quarter spent trading, as forecast in our Q1 Outlook, within a $1800 to $1950 range, we see increased signs that the yellow metal could in the coming months make a fresh attempt at reaching a new record above $2100. If achieved, we could see silver, a semi-industrious metal, return to $26 per ounce, lower than our previous forecast of $30, given current economic growth concerns.

After rallying by more than $340 since the November major low at $1615, gold went on to correct around $150, following Fed Chair Powell’s “whatever it takes” warning, only to rally strongly as yields and rate hike expectations slumped in response to the banking crisis. Gold briefly traded above $2000 while reaching a fresh record against the Australian dollar and close to a record against the euro. Whether the price will reach a record against the dollar as well during the coming quarter will, apart from movements in yields and the dollar, depend on Fed funds reaching their terminal rate, an event that on three previous occasions since 2001 helped trigger a strong rally in the months and quarters that followed.

The combination of continued and strong central bank demand, which helped support prices in 2022 when yields and the dollar surged higher, and renewed investment demand via ETFs following months of net selling is likely to be the main engine that support sustainable higher prices. Hedge funds with their non-sticky and directional driven positioning will continue to add an additional layer of strength during rallies, but also weakness during periods of correction.

Copper remains supported by green energy transition

In our Q1 Outlook, we forecast higher copper prices in 2023, but also wrote that after the initial rally, driven by traders and speculators preempting a pickup in demand from a recovering China, the hard work begins to support those gains, with an underlying rise in physical demand needed to sustain the rally, not least considering the prospect of increased supply in 2023, as several projects go live. Overall, we see copper trade predominately within the $3.75 to $4.50 range during the coming months, before eventually breaking higher to reach a new record sometime during the second half.

This is a view that is being shared by some of the major mining companies and physical traders, driven by constrained supplies and the outlook for rising demand for electrification as part of the green energy transition. During March, when crude oil at one point dropped by more than 12%, the loss in copper was less than 4%, and in our opinion, it highlights a metal where rising demand from electrical vehicles, renewable power generation and energy storage and transmission is already offsetting the property slowdown in China - in recent years, a key source for demand - and an economic slowdown in the West.

If, as we believe, this pickup in green demand has only just begun, the prospect for an increasingly tight copper market in the years to come will be the driver that eventually sees prices hit fresh record highs. China, already a major driver for green demand, will see increased competition from the US, where the “Inflation Reduction Act” (IRA), the most significant climate legislation in US history, has led European policymakers to launch the “Net Zero Industry Act” (NZIA), all incentivising further subsidies and support for the transition, and with that, demand for so-called green metals, which among others, also includes aluminum, lithium, cobalt and nickel.

Crude oil caught between DM weakness and EM strength

In line with our forecast, Brent crude spent most of the first quarter trading in the 80’s before the banking crisis and recession fears saw the price slump to $70, as investors rushed to cut their exposure. Starting the second quarter from a lower-than-expected vantage point, we see limited scope for a return above $90 during the coming quarter, as concerns about an economic slowdown in the US and Europe offset an ongoing and strong recovery in China demand. As the IEA wrote in their latest Oil Market Report, the oil market is currently caught in the cross currents, with supply outstripping still-lackluster demand, driving inventories to an 18-month high.

Apart from the current and increased focus on recession negatively impacting demand, the supply outlook has also surprised to the upside, with Russia maintaining production levels near pre-war levels, despite being hit with multiple sanctions from Western governments. With Russia diverting its crude and fuel products away from Europe and its G7 allies towards Asian buyers, especially India and China, but also Turkey, Africa and the Middle East, the overall price supportive impact on the global balances has not yet emerged.

We note that the price supportive backwardation in Brent was maintained during the March sell-off, while refinery margins have widened, both highlighting market conditions that, if maintained, will continue to provide underlying support. Overall, however, there is no doubt that the second quarter would be challenging, with the focus on financial market stability offsetting underlying strength in demand from China and potentially also a weaker dollar supporting the growth outlook in emerging market economies.