The commodity sector began August on the defensive on a combination of weakness in Chinese economic data and the rapid spreading delta coronavirus variant causing renewed worries about the short-term demand outlook. Growth-dependent commodities such as crude oil and industrial metals traded lower while precious metals, having struggled to rally in response to the July slump in US Treasury yields, traded lower as yields and the dollar rose following hawkish Fed comments and a very strong US job report.

Pockets of strength remained with agriculture commodities such as sugar and wheat receiving a boost from what so far has been a very volatile weather season across some of the key growing regions of the world. Gas prices trading at a 2 ½-year high in the US and at record levels in Europe was another area that continued to exhibit strength amid tight supply at a time of strong demand, both raising concerns that stockpiles may not build sufficiently ahead of the peak winter demand period. 

Despite another Covid-19 related cloud, the macro-economic outlook remains supportive with strong growth in Europe and the US somewhat off-setting concerns in Asia where the virus has penetrated fortress China resulting in renewed lockdowns and down revisions to growth. 

The copper market, while rangebound, has during the past couple of months gone from being very bullish to more cautious. A whole host of opposing forces have in recent weeks been pulling the price in opposite directions, thereby causing some uncertainty as to the short-term direction. Overall, however, we still see further upside with the price of High-Grade copper eventually reaching $5/lb, but perhaps not until 2022 when continued demand for copper towards green transformation and infrastructure projects increasingly could leave the market undersupplied. Despite the risk of a slowdown in China, demand growth elsewhere will highlight the risk of rising demand not being met – at least in the medium term – by rising supply which tends to be quite inelastic.  

Currently, supporting the price of copper is the risk of simultaneous strike disruptions at three major mines in Chile, including Escondida, the biggest mine. However, against that we see uncertainty related to signs of a slowdown in China and the general growth impact of the current spreading of the Delta coronavirus variant. Demand for refined copper has also received a small setback after Chinese policymakers reversed a planned ban to scrap metal imports, and finally Fed vice-chair Clarida’s hawkish comments earlier this week about normalization could further dampen investor appetite for metals as a diversifier and inflation hedge. 

CBOT wheat futures traded close to the May high before suffering a small bout of profit taking. Adverse weather developments increasingly point to tighter global supplies due to expectations of lower output from top exporters Russia and the US. Rains have hurt grain quality in parts of Europe and China, while heat and drought have slashed the production outlook in Russia and North America. According to the latest COT report, speculators have only just flipped their position in wheat back to a net long, and further positive price momentum, supported by bullish fundamentals, may force them to chase the market higher. 

However, in the short term, mounting cases of the Delta coronavirus variant may raise doubts over the level of demand while some major consuming nations such as Egypt, Pakistan and Turkey have backed off from purchases in recent weeks. Under pressure from rising prices, the Egyptian President is even considering raising the price of the country’s subsidized bread. Something that was last attempted in 1977 when then President Anwar Sadat reversed a price rise in the face of riots. 

Natural gas prices across the world remain bid on a combination of hot weather driving increased demand for cooling and rising demand from industry as the global economy bounces back from the pandemic. In the US, the price of Henry Hub is trading above $4/MMBtu, the highest price for this time of year in at least ten years on a combination of rising domestic demand and rising LNG exports. This comes at a time when production has struggled to pick up, especially due to the slow recovery in shale oil production, from which gas is a byproduct. 

Much worse is the situation Europe where prices have reached record levels. An unexplained reduction in flows from Russia, combined with rising competition from Asia for LNG shipments, has made it harder to refill already-depleted storage sites ahead of the coming winter. These developments have led to rising demand for coal, thereby forcing industrial users and utilities to buy more pollution permits, the price of which are already trading at record prices. All in all, these developments have led to surging electricity prices which eventually will be forced upon consumers across the continent, thereby causing a major headache for governments and potentially challenging the political will to decarbonize the economy at the agreed rapid pace.

Crude oil traded lower and following several months where the main focus was on OPEC+ and its ability to support prices by keeping the market relatively tight, the focus once again reverted to an uncertain demand outlook caused by the rapid spreading of the Delta coronavirus variant, particularly in key importer China. A development that has led to growth downgrades and raise questions about the short-term demand outlook for oil and fuel products from the world’s biggest buyer.

The latest developments justify the continued cautious approach by OPEC+ towards raising production too fast, too soon. It also highlights why Saudi Arabia and other leading members of the group has been keen on prolonging the current quota system beyond next April. 

The flexibility exhibited by the OPEC+ group during the past year will likely prevent a deeper correction should demand growth suffer a bigger-than-expected headwind from the current outbreak. With this in mind and considering the lack of response from US producers despite high prices, we maintain constructive view on the direction of prices. 

Precious metals: Having just returned from my holiday, the first question I had to ask was why gold was not trading quite a bit higher? During the past month, US Treasury yields have seen steep declines and with inflation expectations not changing much, the inflation-adjusted rate, or real yield, slumped to a record low at -1.22%. Given the historical strong inverse correlation between real yields and gold, the failure this past month to rally has caused a great deal of head scratching among participants, potentially resulting in some long liquidation for fear that a recovery in yields may not be met by the same level of inaction. 

A worry that was confirmed on Wednesday when the first signs of recovering yields emerged in response to hawkish comments from Fed vice-chair Clarida discussing the interest tightening path. The comments which helped send the dollar and yields higher was given additional credibility following a very strong US job report for July. 

Silver meanwhile has witnessed an even greater exodus with its relative value against gold falling to a six-month low after the gold-silver ratio traded back above 72 ounces of silver to one ounce of gold. Responding to this disappointing performance, hedge funds recently cut their net long to just 21k lots, a 14-month low. Silver will need to see the ratio break back below 70 in order to return to the driving seat, but for that to happen gold would first need to weather the potential short-term challenge triggered by recovering yields.  

With gold and silver drifting lower, the hardest hit of the semi-industrial metals is platinum which has seen its discount to gold widen to 800 dollars from an April low at 300. Reasons being the current chip shortage which has curbed auto production, rising sales of EV’s and the current spreading of the delta variant.

Ole Hansen, Head of Commodity Strategy, Saxo Group