By Ole S. Hansen
The world remains in the midst of an unprecedented slowdown as the economic and humanitarian cost of the Covid-19 pandemic continues to rise. Lockdowns, social distancing and travel bans have hit the energy sector particularly hard as people stay at home while planes remain grounded.
The impact on commodities, depending on growth, demand and well-functioning supply chains, have predominantly been negative. Crude oil and related products have borne the brunt as demand has collapsed by an estimated +25 million barrels/day. Faced with the growing risk of running out of storage capacity within months and with that a total price collapse, supported an end of week rally. This on renewed hope that an emergency production cut could be agreed among major producers in and outside of OPEC.
The agriculture sector have seen the negative impact of falling oil prices on sugar and corn through its biofuel link. Cotton has sold off in response to a collapse in clothes sales and lower prices for oil-linked synthetic fibers. Wheat and orange juice (not shown) meanwhile managed to notch up some gains on the initial hoarding of flour, bread, pasta and frozen orange juice by consumers forced to stay at home.
Industrial metals, led by copper, was heading for its first weekly gain in six. While demand has fallen, the price has been supported by the risk to supply from virus-related mining disruptions. In addition, the sector stands to benefit from government initiatives to mitigate the impact of the pandemic.
Investment metals led by gold have seen a very mixed month. Gold has held its own with strong haven demand through ETF’s offsetting headwinds from lower inflation expectations, a stronger dollar and weak demand in key markets such as India and China. Silver’s 50% link to industrial applications helped send it sharply lower with its relative cheapness to gold rising to a multi-decade high.
Crude oil: Extreme volatility reigns in the energy market as the market has swung between focusing on a total collapse due to lack of storage and renewed hopes about production cuts. Having fought off sellers at $20/b, WTI crude oil surged on news that Trump was seeking a production cut deal with other major producers. While countries like Russia and Saudi Arabia undoubtedly have been shocked by the collapse in demand and price, it is the immediate threat to the North American oil industry which triggered the prospect for a deal to be struck. During the past week, several US and Canadian oil varieties traded below $10/b and well below the cost of keeping operations alive.
The market rallied into the weekend on news that an OPEC-organized meeting of producers on April 6 would discuss a 10 million barrels/day production cut. A cut of this magnitude would do little to offset the current loss in demand, estimated at between 20 and 35 million barrels/day. It would, however, buy the market a bit more time to recover from the pandemic before running out of storage capacity. With current volatility above 100% and the risk of renewed weakness, investors looking for a longer term bet on rising oil prices will be better off looking at individual oil companies with strong balance sheets or ETF’s providing exposure to a basket of oil companies.
Gold has settled into a wide $1570/oz to $1650/oz range with current developments providing a case for a move in both directions. Sellers have been focusing on falling inflation expectations from lower commodity prices, a stronger dollar and weak demand from the world’s two biggest buyers; China and India. The potential for the Russian central bank becoming a seller to fund a growing budget deficit also attracted some attention.
Against these short term developments the continued strong demand for gold through ETF’s highlights the continued demand for safe havens and alternatives to stocks and bonds. As a recession takes hold, the potential for even more easing from central banks is likely to keep real yields, a key driver for gold, anchored in negative territory. In our Q2 Outlook published this week titled “A world out of balance” we focused on the aftermath of the current crisis.
The global economy has become a financialized super tanker fueled by credit and low interest. With helicopter money hitting the market over the coming months, we see the tanker heading from a The Port of Deflation to a new destination called The Port of High Inflation. Into this period we want to be long volatility and commodities, such as gold.
Silver remains troubled by its March collapse to a multiyear low and so far it has only managed a weak correction back to $14.50/oz. The gold-silver ratio has recovered to 112 from a peak above 125 (ounces of silver to one ounce of gold). For that to recover back towards its long term average close to 80 the demand outlook for industrial applications first need to stabilize. Some virus-related mining disruptions in Mexico, the world’s biggest producer, could if realized also provide some support.
Cocoa is currently looking to establish support at $2200/t after having fallen by 25% since February. The coronavirus impact on demand has shifted the focus from a supply deficit to a surplus. Four weeks of aggressive selling has now cut the speculative position held by funds to neutral from a near record long. On that basis the price is now more receptive to price friendly news.
Sugar is another soft commodity that has seen a dramatic collapse in recent weeks. From a 3-1/2 year high at 16 cts/lb in February it hit 10 cents/lb this past week. Sugar is often closely linked with crude oil as the demand from ethanol produces ebb and flow with the price of crude oil. The correlation increased during the past month as the corona pandemic and oil price collapse sent it tumbling. Having reached important support at 10 cents/lb the price is likely to be very receptive to further gains in the price of oil. Hedge funds held a net-short in the week to March 24, another requisite required for the market to attract renewed buying.