Commodities sell-off pauses despite continued focus on trade

Commodities have begun to find their footing with the Bloomberg Commodity index trading higher for a second week. This follows a 10 per cent loss since June when the “trade war leading to lower growth and demand” narrative took hold.
Some of the major drivers behind the broad-based rally this past week:
n Grains (3 per cent): Hot and dry weather across key growing regions lifted wheat while a $12bn US aid package towards US farmers hit by tariffs and an expected pickup in demand from Europe helped stabilise soybeans.
n Industrial metals (1.8 per cent): China introduced new stimulus measures through tax cuts, infrastructure projects and easing capital requirements for some banks.
n Energy (2.4 per cent): Crude oil bounced but is likely to remain range-bound with growth concerns and Iran sanctions impact being offset by a pickup in supply from major suppliers.
n US and Europe put new tariffs on hold after declaring a ceasefire to their trade war.
n The months-long dollar rally showed signs of grinding to a halt.
n Hedge funds selling likely to ease after having cut bullish bets across 24 major commodities by almost 2/3 since March to a 13-month low.
Precious metals, led by gold, were one of the exceptions given the current strong correlation with the Chinese yuan which continued to weaken. Silver was lower for a seventh consecutive week, its worst run of weekly losses in almost 18 years. Soft commodities such as sugar and coffee felt the pain from renewed weakness of the Brazilian real.
HG copper rose for the first time in seven weeks following a 20 per cent slump since early June which took it to a one-year low. The potential for new infrastructure projects in China, the trade war truce between the US and Europe, and troubled wage negotiations at the world’s largest mine in Chile all helped lend support.
Having given back almost half the gains achieved between 2016 and January this year these developments have helped stabilise copper and industrial metals in general. An improved fundamental and/or technical outlook could now potentially trigger renewed buying. Not least considering hedge funds have all but given up seeing higher prices and now hold the biggest net-short (purple line) in almost two years.
In the grains sector a recovery now seems to be under way, led by wheat, with multiple important growing regions from Europe and the former Soviet Union to Australia all reporting challenging conditions due to drought. The lack of rain across Europe has turned normal green grazing fields into something that resembles sandy beaches. As a result of this, farmers have been forced to dig into their winter feed stocks in order to keep their livestock alive and this development is currently driving wheat prices higher with buyers looking to cover/hedge their winter requirements.
Gold has become increasingly impacted by its inverse relation to the dollar. More specifically, the Chinese yuan, as the ongoing trade war between the US and China has been driving the price of both the yuan and gold lower against the greenback. The correlation, as seen below, has been rising during the past few months with gold drifting lower during a time where the Chinese government has allowed its currency to weaken in order to offset the drag on the country’s growth caused by US tariffs on billions of dollars’ worth of goods.
The factors which impact the performance of gold changes over time. While the dollar always remains one of the biggest source of inspiration, the specific currency to measure against varies. A year ago it was the strong positive correlation to the Japanese yen and negative correlation to US real yields that provided most of the directional input.
Strong US growth during the second quarter has kept stocks supported and bond yields relatively stable. This, however, could be as good as it gets with the impact of raised trade tariffs, higher gasoline prices and higher funding costs beginning to be felt during the second half. An escalated trade war, which reduces growth prospects further, is likely to cause a rethink by the Federal Open Market Committee in terms of raising interest rates further.
Gold is once again looking for buyers ahead of $1,200/oz, an area which has provided edsupport in the past and which represents a 50 per cent retracement of the $329/oz rally seen between December 2015 and July 2016. For this level to hold, however, it is clear that the dollar appreciation needs to pause or reverse, especially against the yuan as highlighted above. Selling pressure from funds may also begin to slow after they accumulated the biggest gross-short on record. This has left gold in a better position to react to so far absent price-friendly news.
Brent crude oil’s correction lower from $80/b during early July seems to have run its course for now. What triggered the sharp correction was a combination of news impacting the potential outlook for demand and not least the short-term outlook for supply. Trade tensions, which have been growing during the past three months, have increasingly led to worries that global growth and demand may suffer, especially among emerging market economies already challenged by the combination of a stronger dollar and a rising cost of servicing debt in dollars.
What probably did most of the damage was the easing of supply disruptions from countries such as Libya and Canada and reports that the three Opec Gulf Cooperation Council members of Saudi Arabia, UAE and Kuwait had already begun ramping up production and exports. The timing mismatch between when these extra barrels are hitting the market and when they are actually going to be needed — later in the year when US sanctions against Iran begins to bite — has helped created a temporary oversupply in the market.
(Ole S Hansen is Head of Commodity Strategy at Saxo Bank)