Commodities higher on cocktail of dollar weakness

Renewed risk appetite has been led by the recovery in global stocks which posted their best week of gains in six years. The dollar hitting its lowest level since 2014, together with a rising inflation focus, supported a strong week for commodities with funds continuing to have an appetite for broad-based commodities funds. Gains were seen across all sectors with industrial metals on top ahead of the Chinese Lunar New Year holiday. Despite rising bond yield differentials increasingly favouring the dollar relative to other major currencies, the greenback continued to weaken.
The focus right now is the risk that the massive fiscal stimulus introduced in recent months through tax cuts may eventually hurt the US economy through rising bond yields and rising inflation.
Given the inverse correlation between the dollar and commodity prices these developments have created a sweet spot for investor interest in commodities.
The broad-based interest was reflected in the synchronised gains seen across the different sectors this past week.
Gold is once again on track to challenge an area of resistance which has been rejected on numerous occasions during the past couple of years.
Silver, meanwhile, continues to raise a few eyebrows as it trades at a 22 month low relative to gold despite the strong gains seen among industrial metals.
Crude oil, led by WTI, recovered close to half of its early February slump as the dollar weakened and US weekly inventories rose by less than expected.
We turn neutral on oil after seeing the price almost reach our Q1 downside objective. However, a weaker dollar driven by increased concerns about the US economic outlook is not a strong enough foundation from where a price recovery can be established.
On that basis we expect the market to remain range-bound for the time being.
Challenging weather conditions in the US as well in South America continue to support the destruction of a fund short position that reached a record just a few weeks ago on January 19.
An ongoing drought in Argentina has led to downward revisions to both the soybean and corn crops, while parched conditions in the US plains is likely to reduce the harvest of hard red winter wheat.
The Bloomberg Commodity Grains index could potentially begin to challenge the downtrend which has existed since 2012.
Natural gas came bottom of the pile as strong winter demand continues to be offset by record production.
With the market running out of heating days to dent inventories further, the risk is that the summer injection season could raise stock levels to a record ahead of the 2018-19 winter season.
As a result of these developments Natural gas has slumped by 22 per cent this month and is once again challenging key support at $2.52/therm, a level which has provided support on four previous occasions since 2016.
After falling by more than 12 per cent and after almost reaching our downside target for this quarter, crude oil is showing increased signs of stabilising.
However, a weaker dollar driven by increased concerns about the US economic outlook is not, in our opinion, a strong enough foundation from where a price recovery can be established.
During the past week the three most closely watched market forecasters Opec, the EIA and the IEA all released their monthly updates on the outlook for global supply and demand.
While there tends to be a difference in the outlooks, especially between the International Energy Agency (representing consumers) and Opec (representing producers), the trend towards rising non-Opec supply and steady demand continued.
The tightening of the global oil market that followed production cuts from the Opec+ group last year helped support a return to backwardation.
Such a situation where the first futures contract trades as the most expensive relative to the rest of the curve, supported a strong and eventually unsustainable accumulation of speculative bets from hedge funds.
The correction seen during the past couple of weeks was driven by the stock market rout and an oil market that had run out of the price-supportive news that was needed to support a speculative bet exceeding 1 billion barrels.
Not least after US stocks began their seasonal climb, albeit at a slower than usual pace, and US production broke above 10 million barrels/day.
The chart below shows how the recent correction have failed to negatively impact the price supportive backwardation.
Fundamentals, in other words, remain healthy with the biggest risk being the potential need from hedge funds to further reduce exposure.
Hedge funds cut bullish bets by less than 5 per cent in the two weeks to February 6.

Ole Hansen

[Ole Hansen is Head – Commodity Strategy at Saxo Bank]