Commodities pause as US yield spike boosts dollar

Worldwide growth combined with rising inflation expectations have supported demand for commodities so far this year. The broad-based Bloomberg Commodity Index trades higher by 1.5 per cent year-to-date with its 36 per cent exposure to the agriculture sector acting as a drag.
The energy-heavy S&P GSCI, meanwhile, is up by 4 per cent due to the out performance of crude oil and products.
Data collected by Bloomberg show that investment flows into broad-based commodity funds have risen by $773 million so far this year. This is only exceeded by flows into precious metals, especially gold, which have received $787 million.
A redemption of more than $1.1 billion was seen in energy, not least from funds tracking the performance of natural gas.
Crude oil remains close to key resistance following a week where record US production and the first inventory rise since November was more than offset by updates showing a continued strong compliance among Opec members currently keeping production capped. Robust upgrades to oil price forecasts from major commodity houses such as Goldman Sachs and JP Morgan added to the bullish sentiment.
Despite what looks like a market in need of a correction, gold traders continue to be reluctant sellers despite seeing the metal pause at multiyear resistance. The current focus on rising inflation continued after the US job report for January showed strong rise in average earnings. Some long profit taking was seen following the report with rising bond yields and a stronger dollar offsetting stock market weakness. Rising real yields and expectations of more US rate hikes may pose a drag in the short-term.
Relative silver and platinum weakness points towards continued gold demand from investors looking for safe-havens and diversification while Bitcoin’s near-61.8 per cent correction of the 2017 rally may also have added some support.
The recent recovery across key crop futures traded in Chicago paused with the focus alternating between weather changes, export data and currency developments. The market is hanging onto every weather forecast, both from South America due to its impact on corn and soybeans as well as from the US where increased drought conditions have been causing stress to high-protein winter wheat in Kansas and Oklahoma.
A large overhang of global supplies, however, continues to weigh on the market, thereby reducing the appetite for aggressive short-covering.
The soft sector with the exception of cotton remains out of favour with sugar posting the biggest monthly loss since last March. A projected global surplus for the 2017-18 season continues to be revised higher. Sugar’s best chance of a recovery rests with financial traders who once again are holding a record net-short position, thereby leaving the price vulnerable to a recovery should the fundamental or technical outlook improve.
Oil continues to frustrate those looking for a correction following a 57 per cent surge since last June. This past week was another example of how the bulls remain in control as an attempt to correct lower ran out of steam on the day the US Energy Information Administration reported its first inventory rise since November while also noting that US crude production surged higher in November to breach 10 million barrels/day for the first time since 1970.
Instead of moving lower on this news, the market took comfort from a continued outlook for robust global demand growth and surveys showing that the group within Opec maintaining the production cap continues to show a high level of compliance (not least courtesy of Venezuela where its ability to produce and export barrels continues to deteriorate).
Major investment banks continue to raise their 2018 forecasts, particularly Goldman Sachs who now see Brent crude oil trading at $82.50/barrel within the next six months.
Monthly surveys from the major oil institutions kick off next week with the Short Term Energy Outlook from the EIA on February 6. This will be followed by Opec on February 12 and the IEA on February 13.
While keeping the outlook for 2018 demand growth steady, we have seen a gradual increase in non-Opec supply during the past three months.
The technical levels that continue to cap crude oil’s progress are $71.40/b on Brent and $66.90/b on WTI. These levels represent the 50 per cent retracement of the 2014 to 2016 sell-off. A rejection at this level could signal a correction in the region of 10 per cent to 15 per cent while a break would have the bulls taking aim at $81.8/b on Brent and $76.50/b on WTI.
Gold has also been showing a great deal of resilience in recent weeks. After reaching a four-month high on January 25, gold quickly corrected by $33 but has since consolidated with potential sellers hesitating. The rising inflation focus combined with lower bonds and stocks have all provided underlying support this week with a weaker JPY and rising real rates having a limited negative impact.
We conclude that the relative weakness seen in both silver and platinum against gold during the past week is a sign of the yellow metal continuing to be in demand from investors looking for protection and diversification from emerging weakness elsewhere.
Gold remains supported despite the recent rise in US real yields and a continued rise in Fed funds expectations. Market complacency as seen through corporate versus government bond spreads and rising inflation expectations are two of the main drivers behind the current demand for safe-haven assets such as gold.
The long-term chart below shows how gold increasingly has been boxed into a range since 2013. The area of resistance between current prices and $1,380/oz could, if broken, signal an extension towards $1,483/oz. With inflation increasingly becoming a theme it would probably take a sharp reversal of the recent dollar weakness to create another top in the market.
The spike in hourly earnings in the US job report for January added some selling pressure on Friday but at this stage the uncertainty across bonds and stocks looks likely to keep corrections relatively shallow.

Ole Hansen

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