Commodity markets have always been vulnerable to a boom-and-bust cycle in which production and consumption fluctuate with price. High prices thwart demand and encourage supply, while low prices have the opposite effect. In 2022 we were able to see this phenomenon in all its glory.
Yet, the natural commodity cycle was distorted in 2022 by emotions and by newbie -- or "green" -- speculators who were flush with cash -- ready for any asset they deemed to have upward momentum.
The primary narrative in the second and third quarters of 2022 pointed toward higher prices for the commodities most impacted by the Russian invasion of Ukraine, namely crude oil, wheat, and natural gas. Yet, each of those commodities have suffered swift drawdowns due to a severe case of buyer's remorse; when margin calls are triggered, fundamentals nor technical analysis matter to price action.
Crude Awakening
Crude oil speculators have been perpetually long on the market for several years. According to the Commodity Futures Trading Commission's Commitments of Traders Report, large speculators (considered smart money) are net long a mere 230,000 contacts; this is the least bullish these investors have been since 2016. In the past, liquidation events of this magnitude in crude oil have come with trend changes.
For 2023, we expect the lower end of the price range for WTI crude oil futures to be $70 to $65 per barrel with the upside potential in the mid-$90s, maybe into the low-$100s if there is a fundamental surprise. In short, we think buying the dips in 2023 will be a better approach than selling the rips.
If it weren't for two consecutive black swan events hitting the oil market, we would have likely seen the price of crude oil slowly trade higher in a channel that began in late 2019 and extended through to today. According to the weekly chart of oil futures and the aforementioned channel, the nascent stages of the trading pattern produced resistance estimated to be $65 and support near $40. Over time, the progression of what appears to be the natural uptrend has led to channel resistance near $95 and support at $70. As we've witnessed in March 2020 and March 2022, the oil market sometimes treats these technical levels as suggestions rather than rules. Nevertheless, it took multiple highly unusual events and market panic to stray from the pattern. We've pointed this trading channel out on numerous occasions this year as prices were descending back into the channel in the mid-to-low-$90s. We are currently approaching the channel's lower level ($70) and believe this level, or moderately below, will act as a floor.
It is also worth noting on the weekly chart that the 200-week moving average lands at $65. In light of thinly traded holiday markets that extend into the early stages of the new year, lines get blurred, and things get messy; thus, a quick probe to $65 is a relatively reasonable prospect. In any case, the weekly chart suggests a high probability of the oil market turning the corner somewhere near $70 and $65 per barrel. $70 has already been tested and has held, that might 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 that allocate investor funds into futures contracts. In the frenzy, there were too many investment dollars making their way into wheat futures via ETFs and outright futures buying than the market could absorb. The fuel to the fire was the CME Group's daily price fluctuation limits that prevented futures traders and ETF fund buyers from gaining the upside exposure they desired; this created a price vacuum in which there were desperate buyers but few sellers. Not surprisingly, the resulting parabolic rally was not sustainable.
Wheat peaked near $14 per bushel in March and has traded as low as $7. Just as $14 was unsustainable, so is $7. Both extremes were made possible by emotional decision making, but in 2023 I believe price action will be more reflective of fundamentals than it was in 2022. A break above $8 leaves $10 in play, this is the pre-war trendline. Like oil, wheat could be setting up for a buy-the-dips year.
Unnatural Trends: Natural Gas
A common assumption is that natural gas prices will go up during the winter months due to cold weather contributing to consumption. But the futures markets generally price a weather premium into the market going into the winter season; as a result, the path of least resistance is generally lower for natural gas through December. Further, the Freeport LNG plant closure mitigated the ability of U.S. producers to export natural gas to Europe to make up for the Russian shortfall. The port closure provided a much-needed opportunity to replenish domestic supplies and put downward pressure on prices. The plant is slated to open in the coming weeks, not months. This should eventually offer some support to gas prices.
As marked by the long-term uptrend support line, the current natural gas futures flush should run its course near $4.60 to $4.25. With the chart looking favorable to the bulls, the speculators seemingly on the wrong foot going into the cold season, and a potential reopening of the Freeport LNG port, we suspect the best trades will be getting bullish on dips.
