WCU: Agriculture rally continues despite dollar strength

Ole Hansen

Head of Commodity Strategy

Summary:  Just like the stock market, the commodity sector ran into profit taking this past week. Following six consecutive weeks of gains the Bloomberg Commodity Index lost 1% with the main driver being the abrupt turnaround in the dollar. The agriculture sector led by coffee, soybeans and wheat managed another weekly gain with underlying supportive fundamentals more than off-setting the pull from a stronger dollar.


Just like the stock market, the commodity sector ran into profit taking this past week. Following six consecutive weeks of gains the Bloomberg Commodity Index lost 1% with the main driver being the abrupt turnaround in the dollar. The Greenback received a bid, especially against the euro, after responding to a “line in the sand” comment from the European Central Bank when the EURUSD reached €1.20, the highest since May 2018.

Crude oil saw a long overdue expansion to the downside of the recent tight range after demand recovery concerns, the upcoming refinery maintenance season and the stronger dollar helped trigger some profit taking. Gold’s failure to reclaim $2,000/oz led to selling as the dollar suddenly strengthened and yields moved higher in response to better-than-expected US economic data. While gasoline demand has recovered, a glut of distillates such as diesel and jet fuel, both unavoidable products in the process of producing gasoline, saw ULSD Diesel drop to the bottom of this weeks leaderboard. 

The agriculture sector rose again, albeit at a slower pace than the previous three weeks. Weather concerns, the overall weaker dollar, strong Chinese demand for key crops and the economic recovery following the Q1 collapse have all supported the sector. The top five commodities this past week all belonged to the agriculture sector with coffee out in front followed by soybeans and wheat. 

Gold traded lower but within its established range as the dollar became the main source of inspiration for traders. However, some signs that the metal was running low on fuel emerged after it failed its attempt to break back above $2,000/oz. Despite support from a weaker dollar and 10-year US real yields hitting record lows, the focus quickly turned to the search for support which was found ahead of $1900/oz.

The ugly all-day slide in US equities on Thursday was all but ignored by the wider market. The 5% drop in the Nasdaq only reversed a few days’ worth of gains while occurring at a time where many of the mega cap technology stocks had reached valuations difficult to justify by most metrics. Only an accelerated sell-off in stocks could begin to negatively impact gold. In order to cover losses elsewhere traders may, just like a brief period back in March, turn to gold selling in order to access liquidity.

With gold having failed to benefit from the aforementioned tailwinds earlier in the week, the short-term outlook points to a prolonged period of consolidation and potentially a bigger correction than what we have witnessed so far. In order to determine the direction, the focus will stay with the dollar and the direction of US real yields. As per the chart below the three lower highs is a concern and it may signal the need for a deeper correction as short term longs exit the market looking for better entry levels. The levels of support currently on our radar are:

$1900/oz - Recent lows and a level where some breakout models are likely to exit long,
$1837/oz - The 38.2% retracement of the March low to August high

Source: Saxo Group

Crude oil was dragged lower by weaker margins as refineries struggled with an overhang of unwanted distillates such as diesel and jet fuel. Adding to this the mentioned dollar strength and some lingering concerns about the current pace of demand recovery. Something that was reflected in weaker time-spreads. An example being the spread between the first and the second WTI crude oil futures contract which reached its widest level since June.

The cost of transporting crude oil on the Middle East to China benchmark route dropped to the lowest since May 2018 on signs that Chinese demand was slowing following a record buying spree since the March/April price collapse. The risk of a near-term price weakness also saw demand for downside protection rise with WTI put volumes rising to the highest since mid-June. 

From a trading perspective the break below the uptrend from June may signal a prolonged period of sideways trading with the downside risk initially limited to the low 40’s. An extended stock market correction and/or further dollar strength may together with negative Covid-19 developments pose the biggest threat to our expectations for higher oil prices towards the end of the year and into 2021.

    Source: Saxo Group

    Copper was a market that was left unscathed by dollar and stock market corrections. It quickly found support following a mini correction amid tightening supply of London Metal Exchange inventories which have slumped to the lowest since 2005. The main driver being the Chinese economy which continues to recover from the coronavirus pandemic.

    Silver’s traditional ability to outrun gold in both directions was once again on full display. Earlier in the week it hit a fresh three-year high relative to gold after the XAUXAG ratio briefly dropped below 70 ounces of silver to one ounce of gold. As gold corrected lower silver took another tumble with the ratio widening to 73 while the XAGUSD went looking for support ahead of $26/oz.

    Arabica coffee was the star performer on a combination of a stronger Brazilian real and a tightening market. Inventories at exchange monitored warehouses have fallen to the lowest since 2000. For the past few years ample supply had resulted in one of the most elevated contangos across all commodities. The bigger the contango the more a speculator gets rewarded for holding a short position. From a 12-month contango of more than 10% a few months ago it has now collapsed to less than 3% thereby removing a major incentive for selling into rallies.

    Source: Saxo Group
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