Q3 Outlook: Commodities are set to benefit
Head of Commodity Strategy, Saxo Bank Group
Summary: The global fiscal panic, which is likely to result in governments spending money they don’t have, has the potential to drive a boom in commodities, not least gold as inflation looks likely to come roaring back.
The global fiscal panic, which is likely to result in governments spending money they don’t have, has the potential to drive a boom in commodities, not least gold as inflation looks likely to come roaring back. And a weaker US dollar could give gold and commodities overall the boost that has been lacking in recent years.
The global fiscal panic that we expect to unfold over the coming quarters will drive additional gains across several key commodities. Gold seems best positioned to benefit from a renewed race to the bottom in central bank rates and bond yields, while the risk of a renewed currency war could weaken the US dollar, another positive factor for commodities.
Steen Jakobsen highlighted the risks that renewed monetary policy easing might be unable to move the needle and deliver the sought-after boost to global growth. As a result, we are likely to see a shift towards global fiscal expansion with a focus on infrastructure, environment and inequality. One of the sectors standing to benefit the most from the increased spending of money that governments don’t have is commodities, not least gold as inflation is likely to come roaring back just a couple of quarters after it had been pronounced dead.
Five years of range-bound gold trading look set to come to an end over the coming months as the yellow metal takes aim at $1,483/oz, the 50% reversal of the 2011 to 2015 sell-off. Driving the initial move higher are expectations that global central banks will cut rates to spur growth, which has proven increasingly difficult to achieve with trade wars disrupting global supply chains. The US-led slump in bond yields was another major driver behind gold reasserting its role —not least considering how in Europe an even bigger amount of outstanding bonds has moved into negative yield territory. Why is this important for gold? Because it removes the opportunity cost of holding a non-coupon or non-dividend asset such as gold.
While US Federal Reserve easing cycles in the past have coincided with a strong dollar, we may already have seen the maximum potential for USD strength early in the Fed’s shift, according to John Hardy, our FX strategist. On that basis, we ask if it is finally time for the USD to weaken? That would give gold and commodities in general the tailwind that has been missing in recent years.
The biggest risk to our scenario of rising commodity prices is the potential for a major trade deal between the US and China reducing the markets’ expectations for how much US rates will have to fall. However, looking at the data, we find that credit impulses globally continue to indicate that the economic low point is ahead of us, not behind us.
With silver trading at a 26-year low relative to gold, we see some additional upside, not least due to investors having preferred to trade silver from the short side for a while. The goldilocks scenario that could kick life back into silver would be a weaker dollar, low yields and the mentioned increased focus on fiscal spending.
In copper, we may already have seen the low point around $2.60/lb in high grade and $5,750/tonne in LME. Looking ahead, support will be driven by supply constraints offsetting current demand worries before a pickup in demand occurs. We expect that infrastructure spending and the move towards copper-intensive electrification will only continue to accelerate as the public increasingly calls for action to combat climate change and pollution.
Crude oil’s gyrations during the past six months look set to persist, with multiple drivers creating a very difficult market to navigate. Lower growth leading to a visible reduction in global demand for crude oil was the main theme that helped drive crude oil down to $50/barrel (WTI) and $60/b (Brent) during the past quarter.
To prevent further losses, we expect that Opec and Russia will reaffirm their commitments to keeping oil production capped for the remainder of the year. Additional support should be provided by the continued risk to production from the so-called fragile five, the improved risk appetite from the expected cut in US interest rates, a weaker dollar and, not least, heightened geopolitical risks related to the Middle East. Despite all of these, the risk to global growth remains a major headwind, and barring any escalation in the Middle East, we find the upside risk limited to $70/b in the coming months.
Agriculture commodities will be keeping a close eye on the clouds (or lack of them) in the sky. The problems that farmers in Europe and the Black Sea region faced last year due to drought have moved to the US this past quarter. Torrential rain and flooding have sharply reduced the prospect for US corn production, while the quality of wheat has also been called into question. Soybeans, while also rallying, have struggled to gain momentum amid the trade war and the outbreak of African swine fewer reducing demand from China.
Farmers outside the US, especially in South America, are expected to take advantage of rising prices to produce at will into 2020. The short-term direction of US crop prices however will be determined by weather developments in the US and Europe. On that basis we see prices supported over the coming months.
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