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Commodity Weekly: Virus fears dictating markets

What a week, and what a month it has been for commodities, with three major events all helping to create a roller coaster start to 2020

The WHO has declared the virus a public health emergency of international concern Following a strong finish to 2019 the BBG Commodity Index, down 7%, is heading for its worst month since December 2018 The biggest question that the market is currently asking is when the virus can/will be brought under control

The weekly commodity update takes a closer look at the main events that helped create a very volatile January. Not least the coronavirus outbreak which is once again changing the narrative back towards a lower growth outlook. With this in mind we are keeping a close eye on China-demand dependent commodities from crude oil and soybeans to iron ore and not least copper.

What a week, and what a month it has been for commodities with three major events all helping to create a roller coaster start to 2020. Geopolitical tensions between U.S. and Iran in early January was followed by the signing of the U.S. – China trade deal before, most importantly, the coronavirus outbreak in China created renewed concerns about the human and economic costs.

Read:  Commodities in the crosshairs of climate and inflation

The WHO has declared the virus a public health emergency of international concern (PHEIC) and with this we may see further restrictions on trade and travel between China and the rest of world. Both of which are likely to increase global growth concerns and with that dampen the demand outlook for several key commodities from crude oil and soybeans to copper and iron ore.

Following a strong finish to 2019 the BBG Commodity Index, down 7%, is heading for its worst month since December 2018. Only 3 out of 22 components, led by sugar and gold are positive with coffee and heating oil leading driving the weakness.

The performance table shows how the energy sector has been hardest hit this January. A mild winter across the Northern Hemisphere has kept natural gas under pressure for lack of demand. Crude oil meanwhile ended up more than reversing the strong gains seen during December following OPEC+ cuts and early January when tensions between Iran and the U.S. supported the price. China, the world’s biggest importer of crude oil, is likely to see a slowdown in demand for fuel as planes stay grounded and activity generally experiences a temporary slowdown.

Read: These are the industries that have been hit the hardest by the Coronavirus

Three weeks of selling has taken Chicago soybean futures down by close to nine percent with excitement following the U.S. – China trade deal fading fast. A general horrible month for U.S. farm products has been driven by a diminishing belief that China will or can deliver the promised pickup in demand for U.S. agriculture products. The coronavirus-led disruptions of supply chains in China and the outlook for a bumper crop in Brazil have all conspired to send prices lower. These developments also highlights the need for U.S. crop prices to stay competitive in order to maintain attract demand from overseas buyers.

Industrial metals have also witnessed a sharp turnaround in sentiment with growth optimism at the beginning of the year taking a hit as the coronavirus impact started to be taken into account. Both copper and iron ore are very dependent of Chinese demand and were caught in the epicenter after China introduced travel bans and ordered companies to extend the Lunar New Year holiday. Adding to the gloomier outlook has been recent reports showing a contraction in U.S. and German manufacturing. But the biggest question that the market is currently asking is when the virus can/will be brought under control and for how long Chinese factories will be closed due to the current travel restrictions and extended holiday period.

Read: An AI algorithm detected the Coronavirus outbreak a week before scientists and doctors did

These developments have led to copper once again becoming a favored short as macro funds seek to hedge against a global slowdown led by China. Overall, the net position held by hedge funds have been hovering close to neutral during the past few months. So, while crude oil’s sharp sell-off has been driven by long liquidation as the focus turned from supply disruptions to demand woes, copper has seen a lot of fresh short selling. A development that could support a relatively strong recovery – from short covering – once the virus focus fade. 

Following 12 straight sessions of losses HG copper has returned to key support just below $2.50/lb, an area from where the market bounced on two occasions in 2017 and 2018

Source: Saxo Bank

Gold, the go-to metal in times of raised uncertainty, has surprisingly been struggling to live up to its safe-haven credentials these past couple of weeks. During this time supportive developments such as the drop in global bond yields and global stocks and increased expectations for future FOMC rate cuts have only managed to lift the price by less than 2%.

Despite the lack of price gains, demand for bullion-backed, exchange-traded funds have been strong during this time. Total holdings have reached 2571 tons (Source: Bloomberg) and now sits just 1.5 tons below the previous record from December 2012. The lack of response has been driven by a combination of investors already holding elevated long positions and concerns that Chinese buying may pause.

Read: US equities unmoved by US-China trade deal

While we maintain a bullish outlook for different reasons in 2020, the market may once again be exposed to a small correction. Unless we see a further deterioration in virus-related news leading to further stock market weakness, the short term upside is likely to be limited. It raises the risk of a correction lower should the steep trend-line from mid-December give way.