Global commodities boosted by a fading dollar

Seven consecutive weeks of dollar selling has supported a strong rally in commodities, not least energy and precious metals. It culminated last week when the Bloomberg dollar spot index, which tracks the performance of the dollar against ten leading currencies, including the Chinese yuan, reached a fresh 3-year low. Crude oil managed to recover half of what was lost during the 2014 to 2016 selloff while gold once again began challenging the area of resistance above $1350 where it had been rejected on three previous occasions since 2014.
Natural gas surged higher and broke the trading range which had prevailed for more than a year. Big consecutive weekly inventory draws and the outlook for continued cold weather into February finally tipped the scale in favour of the bulls despite the current run of record production.
The softer dollar also helped support the grains sector which showed a rare sign of life. This occurred on a combination of increased export competitiveness for dollar-denominated contracts and the need for funds to reduce what up until recently had been a record short position across the three key crops of corn, wheat and soybeans. While this supported Chicago traded crop contracts the euro-denominated milling wheat contract traded in Paris struggled. With the negative fundamentals in terms of the current overhang of supply not having changed to any large degree, it remains to be seen whether the sector can trade much higher on just the currency correlation.
Gold continued its week-long rally and despite the need to consolidate it managed to climb to the key area of resistance between $1,357 and $1,380/oz. The various factors normally determining the direction of gold and precious metals in general are currently stacked in favour of the metal at this stage.
The biggest drive undoubtedly remains the dollar which for the past seven weeks has provided an almost constant level of support as it continued to weaken. But besides the greenback, several other drivers should be mentioned.
n US rate hikes of which we have seen five so far in this current cycle all marked a low point in gold from where it recovered. The latest rally kicked of following the December 13 rate hike.
n What is the real level of inflation? While US CPI seems anchored around 2 per cent, the New York Fed Underlying Inflation Gauge (UIC) has risen to its highest in more than 10 years.
n Real yields remain range-bound with rising nominal yields being offset by rising break-even yields.
n The overall commodity price trend is pointing higher and gold benefits from this by being a major constituent in most major indexes.
n Current market complacency with compressed volatility across most asset classes and stocks at record levels have increased demand for tail-end protection and diversification.
n Geopolitical risk indicators have increased since Trump took office driven by the risk of a major diplomatic crisis and his controversial-at-best tweeting habits. Current focus is on the risk of trade wars, North Korea and Iran versus USA.
n Economic data from the US have generally been missing expectations this past month thereby raising the risk of a US economic slowdown.
n Investment demand remains firm with holdings in exchange-traded products at a 55-month high on steady demand from long-term investors while hedge funds have been aggressive buyers since mid-December.
Gold reached resistance at $1366/oz before finding sellers and after having rallied $130 since December 12 and without any significant pullback, the yellow metal increasingly looks in need of consolidation. Underlying demand remains strong and only a significant change in the current negative dollar outlook can hurt this sentiment. However, a healthy correction back towards $1316 should not be ruled out at this stage.
A longer-term chart shows that a break above $1380/oz could see gold targeting $1,484/oz.
Crude oil continued higher as it found support from dollar weakness, supportive comments from Saudi Arabia and Russia and a continued reduction in US crude oil stocks. The rally only paused after both WTI and Brent crude oil managed to recover half of what was lost during the 2014 to 2016 selloff.
A combination of a seasonal slowdown in refinery demand and rising gasoline stocks due to lower demand during the winter months and the continued rise in production is soon likely to pause the record stretch of weekly crude oil inventory reductions.
Once that happens the market is likely to turn its attention towards the relentless rise in US production which could soon breach 10 million barrels/day. Combined with a record long position of close to 1.1 billion barrels held by speculative accounts this is likely — at minimum — to trigger a halt and potentially, a correction.
Given the impact on the price of oil of a few hundred thousand barrels per day in changed supply or demand we see the risk — especially during coming months — skewed to lower prices with Brent crude oil more likely to settle into a $60 to $70 range instead of continuing higher.
A weaker dollar still combined with renewed geopolitical risks (of which we have had plenty during the second half of 2017) are likely to be the key sources of support that could upset our call for lower prices during the first quarter of 2018.
In the short term, the recent highs at $65 in WTI and $70 in Brent crude will offer support while a break could signal the potential beginning of a correction phase.

Ole Hansen

(Ole Hansen is head of commodity strategy at Saxo Bank)