By Ole Hansen

The commodities sector is heading for its worst weekly drop since March following a week that saw broad selling across all sectors except softs which was held up by cocoa and coffee strength amid a worsening supply outlook. The energy sector once again attracted most of the attention with wrong-footed long positions heading for the exit as the market focus increasingly turned from tight supply and geopolitical risks to softer demand following a week that saw manufacturers in the United States, Europe and China all report worse business conditions in October, undoing some of the gradual improvement between June and September. Crude oil at risk

The energy sector is heading for its worst weekly performance since March with losses being led by the notoriously volatile natural gas contract, down more than 10 percent on the week, driven by muted demand for heating as November stays warm and production nears an all-time high. Meanwhile, the sell-off in crude oil and fuel products accelerated this past week with Brent briefly falling below $80 for the first time since July while WTI was hurled below $75 before stabilising.

Prices have increasingly come under pressure as the market focus turned from tight supply supported by Saudi production cuts and a brief spike in the war premium following Hamas’ October 7 attack on the Zionist entity, and subsequent response from the Zionist Defence Force in Gaza. However, while the death toll in Gaza from the Zionist counterattacks continues to rise to unimaginable levels, the prospect of the conflict spreading to the oil-rich part of the Middle East has increasingly been put at near zero.

Instead, the market focus has turned to a weakening demand outlook as the economic outlook weakens in Europe, the US and not least China, the world’s top importer. The turnaround in the outlook and prices has been exacerbated by selling pressures from speculators who bought more than 325 million barrels in the futures market between early July and the end of September on the prospect of Saudi cuts lifting the price. During this time, the gross short slumped to a 12-year low leaving no positions left to absorb a correction like the one we have seen during the past couple of weeks, hence the risk of crude prices falling to low levels that are not justified by current fundamentals.

Brent Crude oil support at around $78.34 with no clear support below until around $72, the May to June lows. Medium-term Brent is in a downtrend that would be further confirmed by a weekly close below $81.94. Likewise, a close above may signal a short-term upside to $84.78, the 0.382 retracement of the most recent sell-off from $93.80.

On the macroeconomic front, the US dollar rose against most of its peers, led by AUD, JPY and GBP weakness while US bond yields rose after Federal Reserve chair Jerome Powell said the US central bank will continue to move carefully but won’t hesitate to tighten policy further if needed to contain inflation. His comments at the IMF conference struck a hawkish tone as he attempted to dial back the dovish repricing seen following the FOMC meeting and NFP miss last week, which led to a 44 basis point slump in US 10-year yields below 4.5 percent, and a 25 basis point drop in the yield on policy-sensitive two-year notes, while supporting the best period for S&P 500 since 2021. Easing financial conditions at a time when inflation is not yet back to the desired level could not be tolerated, and while we believe the Fed is done hiking rates, the FOMC members will have to avoid sending such a message until it is absolutely necessary, in order to avoid markets running ahead of themselves.

The Bloomberg Commodity index which tracks 24 major commodity futures spread almost evenly across energy, metals and agricultural sectors, was heading for a weekly loss of 3 percent, its worst since March led by a 7 percent drop in energy and 2.4 percent in precious metals. The agriculture sector continues to see a growing divide between an ample supplied grains sector following a robust northern hemisphere production season and a softs sector which is seeing a tightening supply of coffee, cocoa and sugar as El Niño-related weather developments continue to impact key production regions on the Southern hemisphere. As a result, the softs sector trades up by more than 30 percent year-to-date while the grains sector has lost more than 10 percent, the latter bringing some relief to consumers around the world.

Short-term cyclical weakness versus long-term structural upside

Despite the current price softness, driven by economic growth concerns in China, Europe and potentially also the US, Saxo holds the view that key commodities are at the beginning of a multi-year bull market driven by CapEx drought due to rising funding costs, lower investment appetite and lending restrictions. The green transformation is creating “greenflation” through rising demand for industrial metals towards “new” energy at a time when miners are faced with rising costs, lower ore grades, growing social and environmental scrutiny, and in some cases resource nationalism.

Note: Ole Hansen is Head of Commodity Strategy, Saxo Bank