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All systems go in the commodities complex as the Fed begins its easing cycle

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

 

SOOJIN KIM
Research Analyst
DIFC Branch – Dubai
T:+971 (4)387 5031
E: soojin.kim@ae.mufg.jp

 

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Global commodities

Commodities are relishing. In the last seven trading days lead-up to yesterday’s FOMC meeting, the Bloomberg Commodities (BCOM) index rose 4%, with crude oil and metals (both precious and base) driving the brunt of the leg higher as investors warmed up to the prospect of a 50bp reduction in the Fed Funds rate. At face value, the case for a 50bp cut was alluring – if only because the Fed (previously criticised for delaying rate hikes), may wanted to avoid the appearance of hesitation with what may be its best prospect to demonstrate it will not repeat the same miscalculation when lowering rates. In other words, collective psychology matters – just as much as data prints. The big question now is what comes next. The uncertainty about the terminal interest rate (where policy is neither restrictive nor simulative of the economy) and the journey to that destination, is top of mind. From a commodities perspective, the speed and magnitude of the anticipated rally will be heavily weighted on the pace of delivered Fed cuts. Yet, we caution that whilst commodities are homogeneously spot, physical assets (driven by the prevailing level of demand and supply), that historically outperform other major assets during Fed easing cycles, heterogeneity abound. In this context, we continue to recommend a more selective, less constructive, tactical approach to commodity investing to harvest returns in an era where inflation is nearing target, there are no signs of an imminent US recession and where markets are pricing in a soft landing. As we have catalogued in recent weeks, our highest conviction views in the current uncertain environment remains long gold, short long-dated European gas, higher implied volatility in crude oil and a delay (not derailment) in copper’s scarcity pricing.

Energy

Oil prices have been cautiously rebounding in recent sessions on both a weaker US dollar and market bets that the Fed will opt for a larger 50bp cut as a pragmatic precaution against further labour market softening. Yet, oil risks remain gravitationally to the downside. Beyond, Chinese malaise and an impending loosening in physical fundamentals, hedge funds’ unprecedented net short positions on Brent crude and refined products (especially, diesel and gasoil), reinforce the bearishness. The big question in today’s oil markets is what price level will prevent (or propel) OPEC+ from increasing (or further lowering) oil production. Whilst it is plausible to assume additional delays beyond the two month extension of the OPEC+ production cuts given the group’s agility and data dependent approach, there is a risk that OPEC+ pivots its strategy in 2025 towards a long-run equilibrium focused on strategically disciplining non-OPEC+ supply (and fortifying internal cohesion), through ramping up its barrels to market.

Base metals

Base metals – led by copper, aluminium and nickel – have clawed back recent losses with the sugar rush from the Fed driving investor positioning in the complex. Though this may be short-lived as elevated inventories and China’s ongoing growth malaise (led by its ailing property sector) is front and centre of attention. Yet, we view that the sharp rates unwind in a soft landing environment offers good entry given late cycle driven scarcity, a tentative revival in global manufacturing and attractive returns.

Precious metals

Gold’s banner year continues with a re-rating higher. We hold conviction in our above-consensus call for gold and forecast prices to rise to USD2,750/oz by year-end and breach the USD3,000/oz threshold in 2025, owing to its role as a geopolitical hedge of first resort in an uncertain operating environment, Fed rate cuts, unprecedented central bank demand for gold, bullion-backed ETFs expanding, the risk of inflationary US policies after the elections from shocks including tariffs and rising debt apprehensions.

Bulk commodities

Iron ore remains stuck near its two year low of ~USD90/MT, with robust supply pushing the market into further surplus, even as Chinese iron ore consumption is tentatively demonstrating signs of stabilisation.

Agriculture

Investor short covering has been underway across the US traded agricultural markets since mid-August, primarily across grain and sugar markets. However, sentiment has soured somewhat in recent sessions, following the recent soft August US jobs report.

Core indicators

Price performance and forecasts, flows, market positioning, timespreads, futures, inventories, storage and products performance are covered in the report.