Dollar relent could offer some near term relief to commodities and commodity-linked stocks

Wednesday, 5th June 2019 09:45 - by Shant

Amid the disconnect between a number of asset classes, one correlation has stood fast and that is the performance of commodities against the US Dollar.  Strengthening of the greenback has wreaked havoc in both precious and industrial metals alike, with price movements in relation to broader risk sentiment in the equity markets providing mixed fortunes along the way. 

Industrial metals have been at the mercy of the market outlook on China, which briefly saw glints of optimism earlier this year as the purchasing manager indices showed some signs of life.  These dissipated as quickly as they emerged, and the usual suspects such as Copper were quick to reflect fresh market angst.   

Much of the Dollar's allure has been off the back of limited alternatives for currency investors, and investors in general to consider, with the backdrop of ample liquidity and healthy yields to support this demand.  Yield differentials have also been a key factor until recently.  This has been predicated on a strong economy in the US, which up until now, has been assumed to have been relatively shielded from the trade wars - but perhaps erroneously so.  There are no winners in trade wars, and this has been proven throughout history, so the latest softness in US production, output and consumption should not come as a surprise to anyone.  As a result, long end yields on the US Treasury curve have taken a battering, with the 10yr Note falling to within 10bps of 2.00%.  Recall in October last year, this benchmark hit a 3.25% high.  Market participants now assume the Fed may be forced to cut rates sooner than anticipated, with curve inversion now at its current extremes. 

Following on from this, one would assume the Dollar could lose some of its shine - and indeed, it has done - but selectively so.  The Japanese Yen and Swiss Franc are primary destinations in times of market stress - the former based largely on repatriation flow.  Consequently, this signals a clear shift towards the traditional safe havens.  This has been represented emphatically in Gold, where the decisive move above $1300 could be pivotal for not only the Dollar but also sectoral differentiation.  

So one of the obvious names to look to in the UK's leading 100 is Fresnillo.  The gold miner whose stock price has been bumping along the low 700's has enjoyed a strong recovery alongside Gold prices, which only a week and a half ago were threatening a move lower through $1275-80 support.  If, as growing sentiment suggests, the Fed are forced to cut rates in a bid to not only temper the ill effects of trade tensions, but to soften the impact of an economy coming off the boil, we could see strong tailwinds from a fresh positive impulse which would also detract from, and effectively weaken the greenback - of at the very least, keep further gains in check.  Buyers would also be protected from a lack of response to accommodative monetary policy - from equity markets in general - though naturally, outright Gold buying would offer better protection. 

Looking at the monthly charts here, we can see that we have multi-year lows from August 2016 come in just under the 600, so we have neared some pretty attractive levels where risk reward at the very least offers decent value.  However, when you marry this up with the prospects for precious metals and the current dynamics which support them, this stock in particular tips the balance in favour of positive inputs, both technically and fundamentally.  

Compared to some of its commodity-linked counterparts such as BHP and Antofagasta, relative pricing also suggests decent value in Fresnillo, but the overriding factors here are Gold, tempered with the potential impact on stocks from a material shift in Fed policy stance.  It offers protection on all fronts, and especially so if the Dollar begins to underperform. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.