Commodities confronted with new headwinds as credit default swaps surge
Global commodities
The precipitous surge in US credit default swaps (CDS) above 2011 levels against a backdrop of rising interest rates signals obstinate strains in market funding, intensified by the US debt ceiling angst and banking turmoil, driving apprehensions that some US Treasuries might default. Such risks could send both bond yields and the US dollar higher, suggesting significant tightness in financial market liquidity so close on the heels of three of the four largest bank failures in US history having occurred in the last two months (SVB, Signature Bank and First Republic). We catalogued the acute risks of the vicious volatile feedback loop where volatility lowers market participation, driving liquidity down and exacerbating volatility further, last year (see here and here). Should the sharp spike in US CDS portend persistent risk aversion, then paper commodity markets may see investors trim their risk tolerance and scale back their commodities exposures. Price corrections followed sharp increases in US CDS’s during the last three episodes (2008-09, 2011 and 2013), with average price declines of -21% for the Bloomberg Commodities (BCOM) index and -32% for WTI crude oil.
Energy
Bearish macro angst is trumping bullish micro fundamentals, with WTI crude oil plunging close to its key resistance level of USD70/b. An acute drop in crude open interest in recent trading sessions suggests the price plunge is being driven by long liquidation than short additions. The key question now is where is the floor for the oil market, with a break below USD70/b set to reignite OPEC+ rhetoric of additional production cuts as well as seeing the US administration refilling its strategic petroleum reserves (SPR). Meanwhile, EU natural gas (TTF) prices have fallen to 21 month lows on seasonal subdued demand while the restocking of inventories during the injection season propels ahead for next winter.
Base metals
Copper continues to remain under pressure with growing frequency of bearish copper net speculative futures positions reflecting investors’ concerns surrounding the global growth outlook against the backdrop of central banks’ monetary policy, the broader banking turmoil and the US debt ceiling debacle, prompting traders to cut copper exposures for cash.
Precious metals
Whilst yesterday may have marked the summit for US interest rates as the Fed’s tightening cycle draws to a close, the same cannot be said of gold. History tells us that gold tends to do well in late cycle periods when rates top out and then cut (see here). Indeed, gold continues to flirt with all-time highs owing to the effects of both fear (short-term driver linked to recessionary angst and a weaker US dollar) as well as wealth (long-term driver linked to both EMs and the US dollar), reinforcing our bullish price forecasts wherein we look for bullion to remain north of USD2,000/oz into 2024.
Bulk commodities
Iron ore’s tumultuous year continues, setting records on the way down with the steel-making staple being dragged lower by a combination of challenges ranging from demand angst in China to abundant seaborne supply, especially from leading producer Australia.
Agriculture
Wheat prices have declined to the lowest level in more than two years, weighed down by prospects for ample supplies from northern hemisphere crops that are being grown this summer. We reinforce our stance from last week that whilst this is positive from a food inflation standpoint, food prices remain elevated, especially in emerging markets that usually comprise a larger weight of food in CPI baskets.
Core indicators
Price performance and forecasts, flows, market positioning, timespreads, futures, inventories, storage and products performance are covered in the report.
CHART OF THE WEEK: OIL NEAR TO BREACHING ITS OVERSOLD TERRITORY
