Dr. Copper: Building a Foundation Amidst Commodity Challenges

Dr Copper: building a foundation

Copper spent most of the second quarter on the defensive, after a less commodity-intensive recovery in China upset expectations for a strong rebound in demand of key industrial metals. However, during June, the prospect of additional China economic stimulus and falling inventories at exchange-monitored warehouses to a five-month low helped trigger a change in sentiment from hedge funds who, up until then, had traded copper with a short bias.

Additional China stimulus or not, we view the current copper weakness as temporary, as the green transformation theme in the coming years will continue to provide strong tailwinds for so-called green metals, the king of which is copper – the best electrical-conducting metal needed in batteries, electrical traction motors, renewable power generation, energy storage and grid upgrades. Adding to a challenged production outlook as miners see lower ore grades, rising production costs, climate change and government intervention, as well as the ESG focus which reduces the available investment pool provided by banks and funds.

From its current level well below $4 we see the High Grade contract eventually move higher and reach a fresh record high, potentially not until the new year when the global growth outlook and the central bank rate focus turns to cuts from hiking.

Crude oil: demand concerns offsetting Saudi supply cut

WTI and Brent crude oil’s sideway trading action since May looks set to continue into the third quarter with global economic growth concerns continuing to be offset by the willingness of key OPEC+ members to sacrifice revenues and market share to support the price. Overall, we believe prices are near a cycle low, but a few more challenging months cannot be ruled out, primarily because of worries that a robust pickup in demand, as forecast by OPEC and the IEA, will fail to materialise. The latter is potentially the reason why Saudi Arabia took the unprecedented step of announcing a unilateral production cut shortly after the group announced production cutbacks.

It all adds up to what could become a challenging few months for OPEC, especially if demand should fail to recover with Saudi Arabia, then raising the pressure on other producers to curb production. For now, the de facto leader of OPEC has managed to send a signal of support which may help prevent a deeper correction, while an eventual recovery, which we believe will occur, paves the way for higher prices.

Until then, Brent will likely remain stuck in the $70’s before, towards the end of the quarter, eventually breaking back above to the psychologically important $80 level, thereby shifting the current 70-80 range higher by 5-10 dollars, where it will be trading ahead of year-end.

Crop production risks downgrade amid rising weather concerns

Following a year-long retreat, the grains sector joined a rally already well established across key soft commodity futures from sugar and cocoa to coffee and orange juice. The grains sector has sprung back to life amid concerns of the potentially damaging impact of drought in key production regions across the Northern Hemisphere, where unseasonably dry conditions have been noted across some the key growing areas, from the Black Sea to Northern Europe and, most recently and not least, the US. Weekly data showing the conditions of the three major crops of wheat, corn and soybeans have all deteriorated, and unless dry conditions are reversed soon by rainfalls, concerns about the eventual production results may underpin prices ahead of the harvest season.

These developments are occurring at a time when markets are on high alert for the potential impact of a returning El Niño, and having formed a month or two earlier than most El Niños, the head of NOAA’s El Niño/La Niña forecast office said it would give it room to grow, raising the risk of a strong event over the coming months. El Niño strongly tilts Australia towards drier and warmer conditions, with northern countries in South America — Brazil, Colombia, and Venezuela — likely to be drier and Southeast Argentina and parts of Chile likely to be wetter. India and Indonesia also tend to be dry through August in El Niños.

In addition to these, the prospect of a long drawn-out war in Ukraine challenging supply from the Black Sea region, and China, following domestic weather woes, becoming the world’s largest importer of wheat could increase global competition for this sought-after crop -- especially in a year where El Niño may reduce production in Australia, China’s biggest supplier of wheat by far.