Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Commodities sector eyes fourth weekly gain amid softer dollar and Fed expectations
Ole Hansen
Head of Commodity Strategy
Key points in this update:
- Softer Dollar and Lower Yields: August saw the commodities sector buoyed by a weaker dollar and declining Treasury yields, with expectations of a Fed rate cut bolstering market sentiment.
- Mixed Performance Across Sectors: Despite gains in industrial and precious metals, and weather-impacted softs, energy and grains faced losses, contributing to a 1.3% monthly rise in the BCOMTR index.
- Uncertainty Lingers: While the month-long correction may have ended, a strong rebound remains unlikely without clearer economic growth signals.
- The market braces for September volatility, driven by the FOMC's rate cut decisions, with industrial metals and gold in focus, as well as OPEC+ production decision
The commodities sector is heading for its fourth consecutive weekly gain, and throughout August the sector has been supported by a combination of a softer dollar, lower Treasury yields, and expectations the US Federal Reserve will announce the first of several cuts at the 18 September FOMC meeting. Traders and analysts watching US economic data have gone from fearing a sharp slowdown to a soft landing, and with inflation continuing to drift lower and China showing signs of improvement, the demand outlook for growth- and demand-dependent commodities has improved.
At this point, however, plenty of uncertainty exists, so while we see the month-long correction as having run its course, the prospect for a strong rebound remains limited until the global economic outlook strengthens further—not least in China and Europe, where expectations for economic growth continue to deteriorate.
Overall, the Bloomberg Commodity Total Return Index (BCOMTR) trades up around 1.3% on the month, and 2.2% on the year, with losses across the energy sector—led by fuel products and natural gas—and a much-reduced loss in grains being more than offset by gains across industrial and precious metals, and not least softs, where weather woes gave sugar, coffee, and cocoa a fresh boost. It is worth noting that cocoa and EU natural gas, both of which trades sharply higher are not part of the BCOMTR index.
September is expected to deliver some volatility, not least driven by the market's response to how the FOMC will present and deliver the expected rate cut, and how it may impact the dollar, which this past week rebounded from a seven-month low. Interest rate-sensitive investors may cheer the beginning of a rate cut cycle, which may increase appetite for industrial metals towards restocking, and gold as the lower cost of carry helps attract fresh demand from ETF investors. In the past seven years, gold has, for various reasons, struggled during September, resulting in an average loss during this time of around 3.2%. While a repeat cannot be ruled out, we suspect a correction may end up being short-lived, given multiple supporting factors amid an uncertain world.
Crude oil will be focusing on OPEC+ and whether the group of producers will go ahead with an October production increase, a decision that has been easier to “sell” to the market during a time when Libya’s political feuding threatens the return of oil supply chaos, with around 500,000 barrels a day already offline after authorities in the east shuttered production amid a fight with the Tripoli-based government for control of the central bank and the money generated from the country’s oil production.
The grains sector will also be watched closely during September as the result of this year’s northern hemisphere harvest becomes known. The sector trades down 20% on the year amid the prospect of another bumper crop being added on top of leftovers from last year, but at the same time it remains the most shorted sector by large speculators such as hedge funds, and any late adverse weather developments could trigger some major adjustments and price moves.
Gold remains boxed in ahead of a seasonally challenging month.
After reaching a fresh record high at USD 2532, gold spent the remainder of the month trading within a narrowing range between resistance above USD 2525 and a succession of higher lows providing support ahead of USD 2500. As we have highlighted in previous updates this year, we are seeing several drivers supporting an ongoing rally in gold, and unfortunately, several of these relate to buyers seeking a hedge against what can best be described as a troubled world. Examples of this include geopolitical issues, from armed conflicts and trade wars to central banks buying gold to reduce their dollar dependency, high levels of debt raising concerns about a credit event, and weakening economies such as China’s.
Gold is an alternative asset that doesn’t offer a yield or dividend like traditional investments in bonds and stocks, and despite these obstacles, which now finally show signs of easing as the FOMC starts to cut rates, gold nevertheless managed to outshine most other asset classes with a 22% gain so far this year, highlighting demand from investors that are not rate- and dollar-sensitive.
The biggest short-term risk is the risk of a buyer’s strike from investors and central banks looking for a setback before adding exposure. In addition, September seasonality points to a potentially challenging month ahead, with spot gold having yielded a negative return in nine out of the last ten years, averaging close to a 3% loss. Only once in 2019 has the end of August hedge fund futures net long been this elevated. However, whether history repeats itself or not, even a correction on par with last year would not change the bullish narrative, only allowing potential latecomers to join.
Silver’s recovery from another deep correction was arrested at the important USD 30.20 level, a break above which may signal a return to challenge the July high at USD 31.75. However, for that to happen, gold needs to hold its ground and the recovery among industrial metals must continue.
Libya disruptions leave the door open for an OPEC+ production increase
Crude oil continues to trade within a narrowing range after once again managing to find support ahead of key levels around USD 71 in WTI and USD 75 in Brent, while the upside remains capped with the 200-day moving average offering resistance in WTI at USD 77.90, and Brent at USD 82.25. Overall, the USD 7.35 range in Brent, the narrowest since May, was caused by the alternating focus on demand concerns as seen through falling refinery margins and geopolitical-related risks to supply, especially in Libya, where production this past week almost halved after authorities in the east shuttered production amid a fight with the Tripoli-based government for control of the central bank and the money generated from the country’s oil production.
Since OPEC+ announced a 2 million bpd production cut in October 2022, Brent has traded mostly sideways, averaging a bit more than USD 83, and while OPEC+ through this strategy has stabilized prices, it has also encouraged non-OPEC+ production, now complicating efforts to increase output without harming prices. However, the loss of around 500,000 barrels a day of supply from Libya and increased focus on compliance from countries that have overproduced oil, including Iraq, Kazakhstan, and Russia, are likely to support a planned gradual increase from October, which if carried out in full, could see 2.5 million barrels per day of supply being added to the market between October and September 2025.
Overall, the opposing forces between soft demand into the fourth quarter, Libya cuts and an OPEC+ increase will likely keep prices rangebound with the upside limited for now.
Copper supported by promising signs in China.
Despite a mid-week wobble driven by profit-taking amid a stronger dollar, copper futures in London and New York nevertheless managed a third weekly gain, supported by fresh demand from momentum buyers and renewed demand from hedge funds that, during the recent and deep 24% correction, had cut their net long exposure in High-Grade futures by 90% to near neutral.
A brief strike action at BHP’s Escondida mine in Chile, the world’s largest, helped kickstart the rebound, despite concerns about demand in China, which remains challenged by a slowing economy leading to elevated stock levels of copper at warehouses monitored by the major futures exchanges in London, New York, and Shanghai. In addition to the prospect of lower funding costs, the industrial metal sector received a boost from news that China, according to Bloomberg, is considering allowing homeowners to refinance as much as USD 5.4 trillion of mortgages to lower borrowing costs, a plan that may support consumption, which has been dragged down by an ongoing property market slump.
Before copper can mount a stronger recovery, demand fundamentals need to improve, potentially supported by restocking through lower funding costs once the FOMC starts its long-awaited rate-cutting cycle. Until then, traders will continue to look out for signs of improvement, not least through the reduction of elevated stock levels at warehouses monitored by the three major futures exchanges.
From a technical standpoint, the recent rally has seen traders turn towards a buy-on-dip strategy as opposed to the sell-into-rallies that was seen during the May to July correction, and while we believe the worst of the correction is over, futures prices in London and New York have yet to challenge key resistance around USD 9500 per ton and USD 4.5 per pound respectively.
Recent commodity articles:
27 Aug 2024: Month-long sugar slide pauses amid concerns of Brazil's supply
27 Aug 2024: Libya supply disruptions propel crude prices higher
26 Aug 2024: COT: Funds boost metals investment as dollar long positions halve amid weakness
23 Aug 2024: Commodities Weekly: Metal strength counterbalancing energy and grains
22 Aug 2024: Persistent supply contraints keep cocoa prices elevated
21 Aug 2024: Weak demand focus steers crude towards key support
19 Aug 2024: Resilient gold bulls drive price to fresh record above USD 2500
19 Aug 2024: COT Buyers return to crude as gold stays strong; Historic yen buying
16 Aug 2024: Commodities weekly: Gold strong as China weakness drags on other markets
9 Aug 2024: Commodities weekly: Calm returns to markets, including raw materials
8 Aug 2024: Sentiment-driven crude sell-off eases, allowing traders to focus on supply risks
7 Aug 2024: Limited short-selling interest observed during copper's recent aggressive correction
6 Aug 2024: Video: What factors are fueling the current market turmoil and gold's response
5 Aug 2024: COT: Broad commodities sell-off gains momentum; Forex traders seek JPY and CHF
5 Aug 2024: Commodities: Position reduction in focus as volatility spikes
2 Aug 2024: Widespread commodities decline in July, with gold as the notable exception
31 July 2024: Crude's month-long slide halted by fresh Mideast worries
30 July 2024: Record demand explains gold's current resilience
29 July 2024: COT: Energy and metals selling cuts hedge fund long to four-month low
4 July 2024: Sluggish US economic indicators boost demand for gold and silver
4 July 2024: Podcast Special: Quarterly Outlook - Sandcastle Economics
2 July 2024: Quarterly Outlook - Energy and grains in focus as metals pause
1 July 2024: COT: Crude long builds ahead of Q3 while grains selling accelerate
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