WCU: Commodities await the greenback’s fate

Ole Hansen

Head of Commodity Strategy

Most major commodities were headed for weekly gains as the short-term focus on growth and demand risks related to emerging markets faded. This was helped by the dollar, which was heading for a second weekly loss. Overall, commodities have had a very bumpy ride this month that at one stage saw the Bloomberg Commodity Index hit a one-year low before recovering. 

With so much of the direction still depending on the direction of the dollar and US interest rates, the focus this week is firmly on the annual gathering of central bankers from around the world at Jackson Hole, Wyoming. On Friday, Federal Reserve chair Jerome Powell made his symposium debut at a discussion about the economy and monetary policy. During the week, the minutes from the August 1 Federal Open Market Committee meeting were released and they suggested that the Fed will continue its tightening agenda until the US economy shows slowing tendencies or the market forces the Fed to rethink. On that basis, another two rate hikes this year are expected with the next coming at the September 26 meeting.

Having been attacked by President Trump for hiking rates (and thereby supporting the dollar) and given the latest EM turmoil and the ongoing trade war, the market was looking for any signs of Powell softening his stance, something that could have an impact on both the dollar and several commodities taking their cues from the strength of the greenback. In it, however, he made no deviation from current market expectations of future rate hikes but the dollar nevertheless traded weaker thereby supporting commodities. 
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Source: Bloomberg, Saxo Bank
From an EM growth and demand perspective, the narrative is arguably that global markets will remain in a fragile state until the Fed backs off its quantitative tightening and rate hiking regime, with the risk of a real crisis linked to EMs' overindulgence in borrowing USD since the global financial crisis. 

Not all commodities received a boost from the weaker dollar. In the grain sector covering the key crops of wheat, corn and soybeans, the market has turned its attention to the US harvest Following a troubled growing season in Europe, CIS and Australia, with the US expected to yield ample supply to offset losses elsewhere. Adding to this, the ongoing trade dispute with China has sharply reduced demand from the most important destination for US-produced soybeans. 

Overall, the Bloomberg Commodity Index covering 25 major commodities traded higher for the first time in three weeks with the aforementioned losses being more than offset by gains in crude oil and products as well as industrial metals. After a few weeks of heavy selling, industrial metals (led by zinc and aluminium) reacted positively to signs of emerging demand from China. Precious metals traded higher but have yet to break any significant levels that may trigger a rethink among speculative traders who currently hold a record short position three times the size of the previous record set in December 2015. 

Crude oil recovered more than half of the July-August sell-off. This came as the market’s attention turned from the potential longer-term impact of lower EM growth to the short-term impact of US sanctions against Iran. 

Tanker tracking data from Platts show that Iran’s crude oil exports have fallen sharply during the first half of August. During this time they saw 1.68 million barrels/day being exported, some 640,000 b/d below the average for July. This will undoubtedly raise pressure on the remaining Opec members and also raise the question whether they will be able to meet the potential shortfall – not only from Iran but also from Venezuela which continues to deteriorate. 

Hedge funds have continued to reduce bullish oil bets in recent weeks and since hitting a record above one million lots (one billion barrels) on March 30, the combined long in WTI and Brent has now seen a 37% reduction. Given its role as the global benchmark, Brent crude oil has seen the biggest reduction to 336,000 lots, down 47% since March.  

During the July to August sell-off it is worth noting that both long and surprisingly also short positions were reduced. The gross-short in WTI and Brent remains close to the lowest in five-years and this highlights the limited selling appetite ahead of the expected Iranian supply drop. 

We maintain the view that Brent crude oil is likely to remain range-bound within a $70 to $80/barrel range. With the short-term focus switching to supply we see some additional upside potential towards $80/b. 
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Source: Saxo Bank

Gold traded higher for the first week in seven as the dollar weakened and after President Trump said that he was “not thrilled” with the Fed continuing to raise rates. 

Under the chairmanship of Trump appointee Jerome Powell, the US Fed Funds rate has been raised three times on top of the two hikes during the earlier part of Trump's presidency.

The market responded by sending the dollar lower with the euro breaking back above €1.15 and thereby returning to a potential €1.15 to €1.17 range. This helped remove some of the euro weakness that emerged the previous week in response to Italian budget risks and EU banks’ exposure to EM debt, and most notably Turkish debt.

For the dollar and short term rates, it’s not a question of what President Trump says but more what the U.S. Fed does. While gold may show continued signs of stabilising, a rally very much depends on whether funds holding a record short begin to take cover. For that to happen, gold needs at a minimum to break above a band of resistance between $1,200 and $1,210/oz.

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Source: Saxo Bank
The combination of ample supply, a speculative attack, and a Brazilian real in freefall at one point helped drive the price of Arabica coffee below $1/lb for the first time in 12 years. For the same reasons, sugar dropped below 10 cents/lb for the first time in 10 years. Using the Bloomberg Commodity coffee index, which includes the roll yield, we find Arabica coffee down by 24% year-to-date and since the 2014 peak it has lost close to 70% of its value.

Ample supply from Brazil, the world’s biggest producer of high-quality beans, together with a significant recent 10% drop in the value of the Brazilian real on the election and general EM nervousness has done most of the damage to price. Additional to this, we have speculative selling from hedge funds which has further suppressed the price. Currently funds hold a record short position of a staggering 1.7 million tons or 28% of the expected global production for 2018-19. As long the technical or fundamental outlook does not improve, they are unlikely to buy back their short positions and thereby support the price. 

Fundamental support, however may start to emerge from reports that have begun to highlight some drought risk to the next crop in Brazil. An unusually early Brazilian coffee flowering has raised some concerns as this phase requires water to support the process towards developing cherries. The dry season normally extends until the second half of September so the next few weeks could be quite crucial. 
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Is Arabica coffee ripe for a bounce after hitting a 12-year low? (source: Saxo Bank)

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