Commodities retreat as China optimism fades

China optimism faded as a stronger USD and hawkish comments from central bankers saw commodity markets give up recent gains last week.

Base metals ended the week lower as optimism over an improving economic backdrop faded. Lower inflation had raised hopes of less aggressive rate hikes by the US Federal Reserve. That was dispelled after most governors said more needed to be done. Hopes of China easing COVID-19 restrictions also eased as new cases continued to rise. However, over the medium term, it has important implications for commodity markets. We now see 2023 in a much brighter light, with downside risks now minimised. Looser quarantine rules suggest an end to the restrictions are closer than we thought. The beleaguered real estate sector has been an even bigger constraint. The property support package announced by Beijing recently thus presents a significant milestone. The measures are unlikely to spark a property boom, with gains to come via resumption of unfinished construction projects. But the risk of a hard landing has been significantly reduced. The prospect of stronger demand for most commodities creates a markedly improved outlook in 2023.

Iron ore futures were up strongly last week amid those efforts to support the Chinese real estate sector. With the risks now tilted to a softer landing, the market’s expectations of stronger steel production have improved. We now expect China’s steel production to rise 2.5% to 1,050mt. This should result in the iron ore market remaining in deficit. In the meantime, news that India has scrapped export tariffs on iron ore could weigh on prices. Exports had dropped to almost nothing in October but are now expected to rebound quickly amid the better outlook in China over coming months.

The resurfacing of demand concerns saw crude oil fall sharply last week. COVID-19 cases in China have risen to near record highs, resulting in further headwinds for oil demand. This has led to a fall in road traffic. A congestion index on the country’s 15 biggest cities based on Baidu data has dropped 2.3% w/w in the seven days to 16 November. There are also signs of a softening in physical markets. Demand for winter delivery of barrels has been slipping despite the looming deadline for European sanctions on Russia crude.

European natural gas gained nearly 20% last week amid ongoing supply side issues. Germany announced last week that it had completed construction of a floating LNG regasification plant. However, it may struggle to secure enough LNG cargoes during winter after reports that the restart of the Freeport LNG export terminal has been delayed. The facility is a major supplier of LNG to Europe. This comes as the market prepares for the first major cold snap of the winter. Temperatures are expected to fall below seasonal norms this week, pushing up demand as households switch on their heaters. Freeport’s troubles also pushed North Asia LNG prices higher. Delays to restarting the LNG export terminal is likely to curb fuel supply to overseas markets just before the peak winter season.

European carbon fell for a third week in a row as activity in the market continued to dwindle amid a lack of fundamental drivers. Weakness across energy market amid mild temperatures is also dampening demand from the power sector. COP27 finished with an agreement to fund poor countries suffering from climate change. However, it failed to reach agreement on greater cuts to greenhouse gas emissions and an end to fossil fuel use.

Gold edged lower after Fed official pushed back against any prospect of a pause in monetary tightening. Policymakers including James Ballard and Neel Kashkari called for further rate hikes to fight inflation.