Already volatile commodity markets now least need a new war in the Middle East

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What a week it has been on the commodity exchanges. The main news is certainly the drop in oil prices, and not just any drop, but the largest weekly drop since March. Oil, which had been on a positive trend for the past few weeks, is now reversing and recording a price drop as the market began to speculate about the level of $100/bbl.

The drop was so significant that not only were all gains in Brent oil prices erased since the beginning of the year, but it is now 1.5 percent lower than it was on the first day of January. This only shows how sensitive, volatile, and unpredictable commodity markets are today. Of course, the drop in oil prices negatively affected metals and agricultural commodities as well.

As for some general indicators, the dollar index DXY is above 106.5 points (the highest in the last 11 months), the EUR/USD ratio remains around the level of 1.05, the S&P 500 index is at the level of 4,300 points, and the fear index VIX is above 19 points. The Goldman Sachs Commodity Index (GSCI) starts the week at 585 points, while the Bloomberg Commodity Index (BCI) is around 101 points.

Should we reconsider the targeted inflation of two percent?

A new war on the horizon? The least we needed right now is new instability in the Middle East. The war between Israel and neighboring Arab countries could bring a lot of (bad) things for all of us. We need to first see whether we will move towards escalation or de-escalation of the conflict in the coming days, and only then can we analyze what consequences this will have for commodities, exchanges, the economy, geopolitics, and more. Will war again become a “market mover”?

The next decade will be marked by ecological and social crises, driven by fundamental geopolitical and economic trends. The “cost of living crisis” is considered the most serious global risk for the next two years, peaking in the short term. The loss of biodiversity and the collapse of ecosystems is considered one of the fastest deteriorating global risks in the next decade, and all six ecological risks are among the top 10 risks in the next 10 years. Nine risks are present in the top 10 rankings, both short-term and long-term, including geo-economic comparison and erosion of social cohesion and social polarization, along with two newcomers at the top positions: widespread cybercrime and cyber insecurity, and involuntary large-scale migration.

Data at the end of 2022 shows a decline in both total and average wealth. The decline is caused by inflation and the depreciation of the dollar against many currencies. Geographically, the loss of wealth is largely concentrated in wealthier regions such as North America and Europe.

The biggest losers in 2022 are the USA, Japan, China, Canada, and Australia, while the largest increases in wealth were recorded in Brazil, India, Mexico, and Russia. Less than one percent of the population owns 45 percent of the world’s wealth. Global wealth has quintupled this century, largely thanks to China. According to projections from the Global Wealth Report, global wealth is expected to increase by just under 40 percent in the next five years.

The UN calls on central banks to reconsider their targeted inflation of two percent to prevent a severe recession. Despite the ECB’s increase in September and President Lagarde’s warnings that inflation is still too high, the market is increasingly focusing on the economy, with the idea that Europe may already be in recession. This vision is reflected in the euro, which has erased all gains made against the dollar from December 2022 to July 2023.

Since mid-July, the euro has lost nearly eight percent against the dollar. According to SWIFT data, the global messaging service for cash transactions, the use of the euro has been declining over the past nine months. Its share in transactions fell from 38 percent in January to 23.2 percent at the end of August, the lowest level recorded in the last twelve years.

Central banks bought 77 tons of gold in August, which is 38 percent more compared to purchases in July, which is a clear signal and sign that central banks continue to accumulate gold. We can also view this as a thermometer for the devaluation of the purchasing power of FIAT currencies.

The largest drop in oil prices in six months

On global markets, oil prices sharply fell last week as interest rates in the US may rise further, which would slow the growth of the US economy and weaken demand. A barrel of Brent oil plummeted 11.2 percent last week, to below $85/bbl, while a barrel of WTI oil decreased by 9 percent, to below $83/bbl. After prices rose more than 25 percent in the third quarter, in the first week of October, oil prices recorded the largest weekly drop in the last six months.

This is a result of traders’ concerns regarding demand, as the growth of almost all major world economies is slowing, and further slowdowns are expected. There are still no concrete indications of a change in restrictive monetary policy; moreover, another interest rate hike is possible by the end of the year in the US, and the cost of money is expected to remain at elevated levels longer than initially expected, as inflation, although easing, is still significantly above the FED’s target level of two percent.

The situation is no better in the eurozone economy, while the Chinese economy, the world’s largest oil importer, is not recovering as quickly as traders had hoped. The strengthening dollar also negatively impacts prices, making oil more expensive for buyers in other currencies.

Futures prices for natural gas in Europe rose above €40/MW. On Sunday, Finland and Estonia noticed an unusual drop in pressure in the Balticconnector underwater gas pipeline between the countries due to a leak. This resulted in a disruption of gas flow, and repairs could take several months.

At the same time, the news that workers at Chevron Corp.’s LNG facility in Australia plan to continue strikes added additional pressure on natural gas prices. However, mild weather forecasts for October, lower demand, high levels of storage capacity, and continuous gas injection, combined with reduced industrial demand despite limited supplies, helped maintain relatively stable prices.

Gas prices in the first month in the Netherlands, the European reference value, are still significantly below levels recorded in the same period last year, when they were around €150/MWh.

Chinese demand for commodities is rising

In recent weeks, hedge funds have been very active, closing their long positions and increasing their short positions within the agricultural sector. This trend carries a strong message – speculators predict a downward trajectory for prices as we approach the end of the calendar year.

What drives hedge funds to build their short position in agricultural markets? There are several factors, but the most important are: a) surprising crop yields – production and stocks of corn and soybeans in the US exceeded expectations; b) low water levels in the Mississippi River – export flows are hindered by unusually low river water levels, affecting the demand for American agricultural products; c) favorable weather – ideal weather conditions across the US supported a successful harvest; d) strengthening US dollar – the recent strength of the US dollar, driven by a hawkish FED, has made American grains expensive on the global stage; e) global competition – cheaper grains from other regions, such as the Black Sea and Brazil, reduce demand for American products.

Although the current environment may seem bearish, it is important to watch for potential growth catalysts that could jeopardize these new short positions of funds. For example, the conflict this weekend between Hamas and Israel reminds us of the geopolitical factors that can quickly impact commodity markets.

Chinese demand for many major commodities has risen at “high rates,” according to Goldman Sachs. The investment bank noted that Chinese demand for copper has increased by 8 percent year-on-year, while appetite for iron ore and oil has risen by 7 percent and 6 percent, respectively, exceeding all expectations.

Goldman Sachs believes that this strength of demand is largely related to a combination of strong growth in the green economy, network construction, and real estate. China’s operational solar capacity reached 228 GW, which is more than the rest of the world combined, according to a June report from Global Energy Monitor.

The world’s second-largest economy is on track to double its wind and solar capacity five years ahead of its 2030 targets.