By Ole Hansen

DUBAI — An index tracking the performance of leading commodities reached a four-month high this week with the sector being supported by gains among industrial metals and grains, most noticeably wheat and copper. Gold meanwhile made a small but nevertheless very important move higher to the highest level since 2011 above $1800/oz.

However, the Bloomberg Commodity Index, which tracks a basket of major commodities in energy, metals and agriculture, weakened ahead of the weekend as the market grew increasingly nervous about the surging coronavirus cases around the world.

In the US, where the three biggest fuel-consuming states are all seeing a surge in cases, real-time indicators are suggesting that consumers are changing their behavior again. In Europe, we are beginning to see signs of an acceleration in new cases, with countries such as Portugal and Bulgaria paving the way for a potential resurgence with tourism beginning to pick up over the next two months.

The risk appetite seen up until now this month was led by an eight-day government-supported buying frenzy in Chinese stocks and fresh record highs in the technology-heavy Nasdaq 100 index. With margin debt from Chinese speculators hitting levels last seen during the 2014 to 2015 doubling of the CSI 300 and subsequent 40% collapse, the government and state media stepped in with actions and warnings to stem the buying.

Grain traders are looking ahead to Friday’s ‘World Agriculture Demand & Supply’ (WASDE) from the US Department of Agriculture for confirmation that the recent 10% rallies in corn and wheat can be sustained. Short covering has been the main driver, with demand for corn having been triggered by the recent lowering of the US planted acreage.

The Chicago wheat future leapt to its highest price in more than two months as the latest crop estimates in major exporting countries such as Argentina, France and Russia raised questions about the level of global supply.

Spot gold finally broke above $1,800/oz, thereby succeeding in what it failed to do on two previous occasions, most recently in 2012. At the same time, with silver breaking resistance at $18.40/oz, the paths towards higher prices have now opened up.

The break could signal an extension for gold towards the 2011 record high at $1920/oz while silver, for now, has found resistance at $19/oz ahead of the next level at $19.65/oz.

Apart from virus-related worries adding support, another major development supporting the latest move higher has been recent movements in US yields. While the nominal yield on ten-year notes remain anchored in a relatively tight range, we have seen breakeven yields, an expression of inflation, move higher leading to a drop in real yields to the current -0.8%.

These developments basically highlight what a US market with yield-curve control would look like heading into a rising inflation scenario.

Rising inflation expectations leading to lower real yields combined with the potential for a weaker dollar are some of the key drivers we believe will continue to support precious metals during the coming months. Adding to this, rising political tensions within the US ahead of the November election and outside with China.

Gold is heading for a fifth weekly gain and, in the short-term, its ability to attract additional momentum above $1,800/oz holds the key. Weakness below that level could raise the risk of another correction but, overall, our bullish outlook has not changed with the record high from 2011 at $1921/oz being the next key level to focus on — a view shared by Goldman Sachs, which sees the price hitting $2000 within the next 12 months.

The combination of rising gold and industrial metal prices should continue to support a relative stronger performance by silver. Its current value against gold at 97 ounces of silver to one ounce of gold remains historical high and on that basis we could see continued gold strength leading to a lowering of the gold-silver ratio, initially towards the 90 level.

WTI and Brent crude oil both traded lower following several unsuccessful attempts during the past few weeks to break resistance at $41/b and $44/b respectively. Crude oil stocks in the US remain close to record levels with the market now worrying that the virus surge in Texas, California and Florida, the three biggest fuel-consuming states, could slow the recent recovery in demand.

Adding to the supply gloom was news that Libya that the civil-war torn country signaled the potential restart of crude exports. This following months of almost zero production compared with 1.1 million barrels/day last December.

The International Energy Agency (IEA) in their latest ‘Oil Market Report’ sounded upbeat given the recent recovery in demand and OPEC+’s successful efforts to curb supply. However, the recent strong growth in COVID-19 cases has cast a shadow over the outlook, thereby putting at risk the market anticipation of a transformation in the oil market from a substantial surplus in 1H to a deficit in 2H.

A development that led to the IEA to finish off by a warning that the large, and in some countries accelerating, number of Covid-19 cases is a disturbing reminder that the pandemic is not under control and the risk to their market outlook is almost certainly to the downside.

While this week’s range in Brent crude has been close to the narrowest since last September, these latest developments still support our Q3 view: that Brent is likely to remain stuck within a mid-30's to mid-40's range.

HG copper’s impressive 45% rally from the March low has almost taken it back to the January peak at $2.886/lb. What is particularly impressive about copper’s run higher is that it has reached levels that were last seen just before China officially announced to the world they had a coronavirus problem. Since then, global economic growth has collapsed while unemployment has surged.

Copper has nevertheless managed to rally due to three developments. The pandemic has raised expectations for increased demand from infrastructure projects, especially in China. This is something we are however yet to see confirmed through a pick up in the stock market value of construction companies.

Adding to this is strong speculative buying, not only on the exchanges in New York and London but most likely also in China given the mentioned surge in risk appetite. The biggest impact however has been a cut in supplies from Chile, the world’s biggest supplier, after thousands of miners have fallen ill with the virus.

While momentum is strong, we are increasingly skeptical about copper’s ability to rally further. The RSI, at its most overbought level since November 2016, is calling for a pullback to somewhere between $2.75/lb and $2.65/lb. The short-term focus in order to determine the next move will be on the behavior of speculators continued appetite for risk and supply developments in Chile.

— The writer is head of commodity strategy at Saxo Bank