Time to start focusing on commodity-linked names again?

Monday, 17th September 2018 08:49 - by Shant

As is a common occurrence in modern day markets, there usually seems to be one major theme dictating financial assets, and in macro world, Dollar strength has been reeking havoc in its path higher.  In commodities, we have seen all but oil prices taking a hit in recent months, with base metals coming under added pressure over concerns that demand from China is expected to wane. 

Credit woes alongside exhaustion in economic expansion (in China) have perpetuated this view, though one of the key drivers (south) has been the power of the greenback as investors have been going hell for leather in the search for yield.  You do not need to go far to find this.  The Fed is the leading central bank aggressively embarking on policy normalisation, though the Bank of Canada are close behind while Bank of England is also taking preparatory steps.  

Dollar strength has also impacted on some of the emerging markets, especially those with current account deficits who need to borrow in US$ to balance the books, and naturally, demand for commodities is dampened yet again as prospects for infrastructure spending darken. It becomes a vicious circle in the end, but we cannot help but think that it is the pace of the Dollar rise which has been more disruptive than anything else, though we are now seeing some moderation developing. 

Indeed, such has been the demand for US paper, that speculators and leveraged accounts have taken to sell 'paper' Gold in preference for Treasuries, pushing the yellow metal down through $1200, where we eventually hit lows around the $1160 mark.  All the while, central banks in China and Russia have reportedly been buying, but for the purposes of this piece, it is as the level of pressure exerted by the futures markets which look to have distorted price and value in the underlying assets and we think that limits have been reached.  Enough is enough so to speak. 

Irrational market behaviour can continue for long periods of time, so far be from me to suggest that excessive positioning in favour of the Dollar and US assets is about to turn tail, but there has been an anti-Dollar mood brewing and it would be naive to think that the major trading nations have not been discussing bilateral trade agreements bypassing the greenback.  

This should given raw materials a boost at a time on a number of fronts, most of which stem and inversely correlate to the dynamics mentioned above.  Having covered some of the levels in Gold, industrial metals such as Copper have seen a sharp drop in the space of the last 3-4 months, and while supply and demand issues can impact on price, a fall of over 20% in such a short space of time does not reflect this.  As we started off by saying, the market is trading off one dynamic, and that is of what we see as an overextended move up in the Dollar.  

At the start of the year, the mindset was firmly fixated on the budget (and trade) deficit, neither of which have been rectified to any material degree.  Indeed, looking at the monthly budget figures out of the US last night, we saw August come in at a $214.1bln deficit vs a $187bln estimate.  This time last year the deficit was $107.7bln.  Surely if the US economy is making hay while the sun is shining, it would do well to pay down debt amid a rising interest rate environment.  Simplistic as this may seem, this was a key factor in Dollar sentiment at the start of the year. We expect this to return with greater gusto as markets will eventually focus on current accounts again.  This is cyclical in FX world, it is just a matter of timing and sentiment thereon is what we have to watch out for.  

Looking at some of the big names in the FTSE, BHP, Glencore and Fresnillo have all suffered at the hands of commodity weakness.  Now may be the time start thinking tactically on global themes, especially for those with a propensity to back stocks with intrinsic value - ie staples. 

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.