If there has been one theme driving global markets over the past month it has been geopolitical risk. At times, the focus has been on the potential for a trade war, primarily between the U.S. and China, but also potentially touching on adjustments to North American Free Trade Agreement (NAFTA). Subsequently, the focus has shifted away from trade policy and back towards the powder keg in the Middle East. While Syria is the headline issue, tensions between the U.S. and Russia are the true foundation.
Commodities have responded over the month. As of 20th April, the Bloomberg Commodity Index had delivered a Year-To-Date (YTD) total return of approximately 2.4%. Over the month of April, this Index was up 2.8%, thereby taking its return from negative YTD territory to positive YTD territory. When the Middle East is in focus, energy and oil historically tend to come to the forefront. On 20th April 2017 (1-Year ago), the price of one barrel of Brent Oil was $52.99. Now, it is nearly $74, rising from approximately $70 during April 2018 alone. Tension in the Middle East has historically been supportive to oil, but we caution investors to overplay that thesis as the production from the U.S. shale producers has been a factor growing in its importance and may create further supply in this market.
One year ago, the price of gold was at about $1280 per Troy ounce, while as of 20th April it was about $1340—driven upward and supported by geopolitical risk more than any other factor. We would also point out that, since commodities are priced in U.S. dollars, movement of the dollar is playing an important role. Over the prior year (20-April-2017 to 20-April-2018), the dollar weakened against all of the G10 currencies. The euro was the biggest gainer—appreciating 15.2%, while the yen was the smallest, gaining 1.7%. Over the month of April 2018, the dollar’s performance was more mixed—the Swedish krona, Japanese yen and Swiss franc actually weakened while the Canadian dollar and Norwegian krone strengthened. The euro and the British pound appreciated slightly over this short period.
- Cocoa and sugar follow different paths however, we expect sugar prices to recover. Unfavourable wet weather conditions coupled with healthy grinding figures in Europe and Asia contributed to cocoa’s strong price appreciation last month. While sugar a prices lagged behind owing to the ample supply situation. We expect the substitution of sugar production for ethanol by Brazil to pave the way for a price recovery.
- Industrial metal prices rebounded from last month’s slump, reflecting easing fears of an escalation in the global trade war. This was accompanied by speculative rallies in aluminium and nickel, both of which saw double digit price increases as a result of US trade asanctions being imposed on Russian metals producers.
- Oil prices rose by close to 10%, to the highest level since 2014. Geopolitical risk has put a premium into oil prices. If sanctions are placed on Iran and Russia, oil supplies could be disrupted, tightening the market further. Outages from Venezuela have already reduced production from OPEC more than the group had intended when they decided to curb a production at the end of 2016.
- Precious metals benefit from ongoing trade tensions and geopolitical risks. Gold appears to have fulfilled its purpose as a safe haven asset. Geopolitical risk continued to weigh on market sentiment, supporting the price of the yellow metal. Silver was the best performer in the sector rising on the back of strong fundamental data releases.
Please find ETF Securities’ Commodity Monthly Monitor for Apr/May 2018 with charts on the left.
Agriculture
Cocoa was the best performer amongst agricultural commodities, rising by 7.1% over the prior month. Unfavourable wet weather conditions in the Ivory Coast, the leading growing country, a are feared to disrupt the harvesting season which is currently underway. The change in a weather conditions are having a pronounced impact on prices as sentiment shifts. The European Cocoa Association (ECA) reported, record high cocoa grinding in Europe up 5.5% in the first quarter over the prior year owing to the high grinding margin. Grinding data in Asia posted the highest figure since records began in 2011. This is also lending buoyancy to cocoa’s price appreciation.
Sugar’s weak price performance can largely be attributed to the ample supply situation on the international sugar market, largely from EU and India. Sugar has staged the weakest performance amongst all major commodities since the start of the year. In response to its price gap with ethanol (that attained a five year high in March), producers in Brazil have more incentive to switch production from sugar to ethanol in the 2018/19 crush. According to JOB Economia e Planejamento, a consultant firm specialised in sugar and ethanol, Brazilian sugar a exports in the 2018/19 season currently underway is expected to decline by 6.5 million tons • over the prior year owing to lower processing. The resulting lower supply from the world’s largest sugar exporter should support a price recovery for sugar.
Industrial Metals
Industrial metals rebounded from last month’s slump, outperforming all other commodity sectors as cooling Trump trade rhetoric soothed investors’ nerves about an escalating global trade war.
Copper was one of the key beneficiaries of improving investor sentiment, posting gains of 3.5% over the prior month. Though prices remain vulnerable to trade tension tantrums, global growth conditions remain favourable, and any signs of a potential US-China trade agreement could present a catalyst for copper prices to retest recent highs.
Leading the industrial metals sector was aluminium, with prices rallying by over 20% in response to US sanctions imposed on Rusal, the world’s second largest aluminium producer. This could leave almost 6% of global aluminium supply cut off from commodity markets. The threat of a potential widening of sanctions to other Russian metals producers also provided an initial boost to nickel, reinforcing investors’ already strong appetite for the base metal.
Energy
With Organization of Economic Co-operation and Development (OECD) inventories of crude oil now falling close to a five-year average, Organization of Petroleum Exporting Countries (OPEC) seems very close to have accomplished its stated mission. However, a large part of the group’s production decline has come unintentionally from Venezuela’s production outages. Global supplies could get even tighter if sanctions are placed on Iran and Russia. We believe it is unlikely that sanctions would be placed on Russian oil exports given the importance of these supplies in Europe. However, the political will-power from the US to put pressure on Iran appears very strong and so we are reluctant to dismiss the risk of tighter sanctions against Iran. For now, we have what appears to be a geopolitical premium in oil price. If geopolitical risks dissipate, we could see prices fall.
Positioning in both Brent and WTI futures is looking stretched. A decline in the geopolitical premium, could trigger a sharp downward movement in prices given the extent of positioning.
Carbon prices continued to rise, posting a 13% gain last month (72% over the past 6 months). With European Union emissions having risen for the first time in seven years in 2017 on the back of higher industrial activity, we could find companies short on emission allowances if the trend continues. Brexit had cast doubt on the EU Emissions Trading System, and weighed on carbon prices in 2017, but last month, the British Energy Minister said that the UK will continue participate in the system until the end of the current phase (2020). That lent further support to the recent carbon rally.
Precious Metals
Gold appears to have fulfilled is purpose as a safe haven asset. Geopolitical risk continued to weigh on market sentiment, supporting the price of the yellow metal. Ongoing trade war rhetoric between the US and China, deteriorating relationship between Washington and the Kremlin, as well as tensions in the Middle East should remain important drivers for short term price movements over the coming months. However, the yellow metal gave up some of its gains at the end of the month on the back of a strong appreciation of the US dollar.
Silver has been the best performer in the sector over the last month. Good fundamental data releases helped an initial rise in price. According to the Silver Institute, industrial demand rose in 2017, for the first time since 2013. On the production side, mine supply decreased for a second year. The price rebound has probably been magnified by a investors covering elevated a short positions. Net speculative shorts in silver futures, reached a record high on the 17 April, right before a sharp spike in the metal price.
Platinum prices appear to have been range-trading for almost 18 months. Once again in April, it got close the $900 support level, before rebounding slightly to post a -2.1% performance for the month. Platinum is an essential material for the production of autocatalysts, thus short term performance is directly impacted by the potential for trade war, as car parts would likely fall into tariffs implementation.
Technical Overview
Positioning
Investors appeared to have turned extremely bearish on soybean oil, as net long positioning declined by 76% over the past 3 months. Short positions have widened by 290% since September 2017.
Net long speculative positioning surged for nickel and copper (LME), rising 82% and 81% respectively. The extent of investor bullishness reflects stronger expected global appetite for both metals.
Positioning in Brent oil futures rose 29.5% to all-time high of 503,023 contracts net long (as on 17 April 2018), which is more than 2 standard deviations above the average for the last five years. With positioning so stretched, we could see sharp downside price movements if anything were to trigger a sudden change in sentiment such as a reassessment of geopolitical risk.
Silver spent most of the first three weeks at the lowest net positioning in history. Despite bullish fundamentals, speculative market participants remained overly bearish in aggregate. This lead to a spike in silver prices on the 18th of April, as short positions were covered following an initial upward move.
Inventories
In the latest report by the US department of Agriculture (USDA), soybean stocks expected at the end of 2017/18 season have been reduced more sharply than expected by the market owing to the large 7 million ton downward adjustment of the Argentinian crop.
LME copper inventories reached their highest levels since 2014, rising 67% over the past three months. This surge hints at potential weakness in global demand since the turn of the year, even as Chinese Q1 GDP growth surprised to the upside at 6.8%. Given recent strength in copper prices however, demand is clearly expected to pick up again over the coming months ahead.
Natural gas inventories continue to remain lean for this time of year. Inventories have declined 43.4% in the past three months, as cold weather has drawn on supplies for heating needs.
Curve Dynamics
Live cattle futures have the steepest backwardation, providing a roll yield of 15.1% driven by softening demand and ample cattle supplies. Meanwhile lean hog futures have the steepest contango, providing a negative roll yield of 9.8% driven by an anticipation of seasonal tight supplies as warm weather usher in increased outdoor grilling.
Most agricultural commodities, with the exception of cocoa, soybean and cotton, are in contango. Negative roll yields run as high as 2.3% and 2.9% for corn and wheat respectively.
The front end of the cocoa futures curve has moved from contango into over the past month yielding a positive roll yield of 0.7%.
Both Brent and WTI futures curves are in backwardation. Brent offers the most pronounced positive roll yield: 1% between the front and the next month future. Curve backwardation has been seen as an important tenet of OPEC’s strategy to drain excess oil inventories as it discourages traders from storing oil in the hope of higher prices in the future.
Technicals
Cocoa prices are trading 29% above their 200-dma on the back of unexpected wet weather conditions and robust first quarter grinding data in Europe and Asia. Meanwhile sugar prices have trailed behind and are trading 13% below their 200-dma, a price recovery is likely to follow if Brazil produces lower sugar.
Nickel’s ongoing rally has left it trading significantly above its 200-dma by 22%. We expect the positive momentum to continue owing to long-term growth trends such as vehicle electrification, and ongoing supply deficits.
Brent and WTI crude oil benchmarks are trading over 20% above their 200- day moving average, highlighting the very bullish momentum behind oil at the moment.
Platinum is trading below its 200-day and 50-day moving averages. Should prices maintain their current level or go further down, the 50-day moving would quickly dip below the 200-day indicator, highlighting the ongoing downward trend.