By Ole Hansen, Head of Commodity Strategy at Saxo

The Bloomberg Commodity Index trades up by 2.4% on the week, reversing some of its early January losses. This comes after the energy sector – natural gas being the exception – joined an ongoing rally across metals, led by gold and copper. The main driver impacting the commodity sector is the prospect of China’s reopening, in turn driving expectations for a pick-up in demand for commodities from the world’s biggest consumer of raw materials. In addition, risk sentiment has also been supported by a continued and broad drop in the dollar as US inflation continues to ease, thereby supporting a further downshift in the Fed’s rate hike trajectory.

The strong gains seen during the past few weeks – especially in gold and copper – have in our opinion showed the correct direction for 2023. However, while the direction is correct, we believe the timing could be slightly off, thereby raising the risk of correction before eventually moving higher.

Copper, the star performer on China reopening hopes

Copper has led a strong start to 2023 for industrial metal prices on hopes of a potential surge in demand from China, the world’s top consumer. This is buoyed by the reopening of China’s economy and increased policy support to fuel an economic recovery to offset the economic fallout from President Xi’s failed and now abruptly abandoned zero-Covid policies. This optimism has been mixing with a weaker dollar on speculation that the Federal Reserve is slowing down the pace of future rate hikes as the inflation outlook continues to moderate. ​

The VanEck Global Mining UCITS ETF – which includes titans like BHP, Rio Tinto , Glencore , Vale and Freeport-McMoRan – trades up 10.5% so far this month, a nine-month high. Glencore makes around 40% of its revenue from copper, while BHP makes 26.7% and Rio makes 11%. In addition, the iron ore futures traded in Singapore have cleared $125 per ton for the first time in six months in anticipation of a strong seasonal pick-up in demand following the Lunar New Year holiday.

The initial and strong rally in copper has primarily been driven by technical and speculative traders expecting demand from China to underpin prices in the coming months. Once the initial move is over, the hard work begins, with an underlying rise in physical demand needed to sustain the rally. During this phase some profit taking may emerge, giving potential buyers another opportunity to get involved.

Copper, up close to 10% this month, trades near a seven-month high with the latest run up occurring when the price broke above the 200-day moving average, now support at $3.8350 per pound. Since then, momentum and technical buying has seen the HG copper contract break several resistance points, the latest being $4.0850 per pound, the 50% retracement of the 2022 sell-off. Before seeing the next extension – potentially towards $4.31 per pound – the metal may need to cool off, allowing for a retracement lower towards the $4 per pound area.

Gold’s positive start continues

Gold jumped out of the gate to kick off 2023 with strong gains as the positive momentum from December carried over into the new year. This supports our view that 2023 will be friendlier towards investment metals, as last year’s headwinds – most notably dollar and yield strength – begin to reverse.

In addition to the above-mentioned supportive drivers for gold this year, we see continued strong demand from central banks providing a soft floor in the market. During the first three quarters of last year, the World Gold Council reported official sector purchases of 673 tons, higher than any full year since 1967. Adding to this a total of 62 tons bought in November and December from the Peoples Bank of China. Part of that demand is being driven by a handful of central banks wanting to reduce their dollar exposure. This de-dollarization and general appetite for gold should ensure another strong year of official sector gold buying.

Adding to this, we expect the friendlier investment environment for gold to reverse last year’s 120 tons reduction via ETFs to a potential increase of at least 200 tons. However so far, and despite the strong gains since November, we have yet to see demand for ETFs – often used by long-term focused investors – spring back to life, with total holdings still hovering near a two-year low at 2923 tons. Speculative technical buying therefore seems to be the main current driver, led by continued demand from hedge funds who turned net buyers in early November when a triple bottom signaled a change away from the then prevailing strategy of selling gold on any signs of strength.

In the short-term, gold looks increasingly in need of a correction, with that risk being supported by lower physical demand while traders get use to higher prices – not least in India where demand, according to Reuters, plunged 79% in December from a year earlier. Gold has not traded below its 21-day moving average since early November, and the January surge has seen that gap widen, but with RSI signaling overbought conditions, a correction towards the lower channel band, currently at $1830, cannot be ruled out.

Crude oil reverses early January losses on China

Crude oil prices rallied strongly this past week on optimism that China will see a robust recovery in demand for crude oil and fuel products. This comes as the nation reverses its zero-Covid policies and recession fears in the US and Europe begin to fade – despite the IMF warning that one third of the world economy would end up in a recession this year. Earlier in the week, a huge 19m barrels build in US inventories – the biggest since February 2021 – had no negative price impact. Higher inventory levels were to be expected, driven by the late December cold blast reducing exports while temporarily shutting down some refineries.

While supply is expected to exceed demand this quarter, thereby keeping price gains capped, the outlook further into the year still points to emerging price support as balances tighten and the impact of rising Chinese demand and sanctions on Russian fuel products from February begin to be felt. Through its active management of oil supply, OPEC+ has helped create the perception of a soft floor under the market, thereby dissuading potential recession-focused sellers from getting too aggressively involved.

In the short term, we see limited risks of WTI and Brent breaking their established ranges – with Brent trading between $75 and $90. However, once spring arrives across the Northern Hemisphere, that stance will change towards a long bias.