Commodity markets have always been prone to boom-and-bust cycles, in which production and consumption fluctuate with price. High prices inhibit demand and encourage supply, while low prices have the opposite effect. In 2022 we could witness this phenomenon in all its glory.
But the natural cycle of commodities was distorted in 2022 by emotion and by new – or “green” – speculators flowing with cash – ready for whatever asset they thought was bullish.
The main narrative in the second and third quarters of 2022 pointed to higher prices for the commodities most affected by the Russian invasion of Ukraine, namely crude oil, wheat and natural gas. Still, each of these commodities has suffered rapid losses due to a severe case of buyer’s remorse; When margin calls are triggered, fundamentals or technical analysis are relevant to price action.
Raw Awakening
Crude oil speculators have been in the market continuously for several years. According to the Commodity Futures Trading Commission’s Commitments of Traders Report, large speculators (considered smart money) have only 230,000 net contacts; this is the least bullish stance among these investors since 2016. Historically, liquidation events of this magnitude in crude oil have been associated with trend reversals.
For 2023, we expect the low end of the WTI crude futures price range to be $70-$65 per barrel, with upside potential in the mid-$90s, perhaps into the low $100s , when there is a fundamental surprise. In short, we think buying the dips will be a better approach than selling the rips in 2023.
Had it not been for two consecutive Black Swan events hitting the oil market, we likely would have seen the price of crude oil slowly trade higher in a channel that began in late 2019 and extends to the present day. According to the oil futures weekly chart and channel above, the evolving phases of the trading pattern generated resistance estimated at $65 and support near $40. Over time, the continuation of the seemingly natural uptrend has led to channel resistance near $95 and support near $70. As we saw in March 2020 and March 2022, the oil market sometimes treats these technical levels as suggestions rather than rules. Still, it took several highly unusual events and market panics for this pattern to deviate. We have pointed to this trading channel on numerous occasions this year as prices fell back into the channel in the mid to low $90 range. We are currently nearing the lower level of the channel ($70) and believe that this level or slightly below will act as a bottom.
It is also worth noting that the weekly chart’s 200 week moving average lands at $65. With thinly traded holiday markets stretching into the early stages of the new year, the lines are blurring and things are getting chaotic; Therefore, a quick probe to $65 is a relatively reasonable prospect. In any case, the weekly chart suggests a high probability that the oil market will turn the corner somewhere near $70-$65 a barrel. $70 has already been tested and held, this could be the low for now but any retest or slightly lower would be an opportunity for the bulls.
No cakewalk: wheat
The 2022 wheat rally was exacerbated by inflows into commodity ETFs, which allocate investor funds to futures contracts. In the frenzy, too many investment dollars flowed into wheat futures via ETFs and direct futures purchases for the market to absorb. The fuel for the fire was CME Group’s daily price swing limits, which prevented futures traders and ETF fund buyers from achieving the desired upside risk; This created a price vacuum in which there were desperate buyers but few sellers. Not surprisingly, the resulting parabolic rally was unsustainable.
Wheat peaked at nearly $14 a bushel in March and traded as low as $7. Just as $14 was unsustainable, so is $7. Both extremes were made possible by emotional decision making, but I believe price action in 2023 will reflect fundamentals more than in 2022. A break above $8 leaves $10 in play, this is the pre-war trendline. Like oil, wheat could be poised for a buy-the-dips year.
Unnatural Trends: Natural Gas
A common assumption is that natural gas prices will increase during the winter months as cold weather contributes to consumption. But the futures markets generally price in a weather premium going into the winter season; As a result, the path of least resistance for natural gas is generally lower in December. In addition, the closure of the Freeport LNG plant reduced US producers’ ability to export natural gas to Europe to help offset Russia’s deficit. The port closure provided a much-needed opportunity to replenish domestic supplies and put downward pressure on prices. The facility is scheduled to open in the coming weeks, not months. This should eventually provide some support to gas prices.
As indicated by the long-term uptrend support line, the current natural gas futures flush should run its course near $4.60-$4.25. With the chart looking favorable for the bulls, speculators seemingly walking on the wrong foot into the cold season and a possible reopening of the Freeport LNG port looming, we suspect the best trades will turn bullish on dips.
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