Sunday 26 June 2022

Can a strong USD derail the commodity bull cycle?

DUBAI, May 19, 2022

The strength of the USD has had little discernible impact on broad commodity performance, and while there are few reasons for the USD to reverse course, analysis signals that a divergence within the commodity complex will continue, a report said.

Beyond rising nominal rates, the other current dominant global macro theme has been the USD strength, reflecting increased hawkishness by the Fed, relative weakness in Europe and China and global risk-off on the back of recession fears boosting the USD’s role as a safe haven asset, said the Mitsubishi UFJ Financial Group (MUFG), a Japanese bank holding and financial services company, in its “Commodities Q2 2022 Outlook”.

The breakdown in commodity-USD correlations can be explained by rising global inflation expectations, a diverging volatility profile between FX and commodities and a strong trade-weighted CNY (currency with the highest beta to commodities).

Specifically, the evidence points to a sectoral deviation between tight commodities (such as energy and grains) that are trading in marked backwardation and those with relatively loose timespreads (such as base metals) – with the former group displaying a lower correlation and the latter relatively higher correlation to the USD.

Exacerbated by the war in Ukraine, soaring refining margins are underscoring extremely tight oil products markets. Severe tightness in the global refining system means that refined oil products such as diesel and gasoline – i.e. what the economy and end-consumers are exposed to – are far more expensive than merely looking at crude prices would suggest. In effect, the real economy is suffering a much stronger energy inflation shock, which matters profoundly for global central banks.

Meanwhile, European gas prices have whipsawed on the continents Russian Rouble payments dilemma.

Base metals
Aluminium, copper, nickel and zinc all remain caught in the bearish crosswinds of Covid apprehensions, largely unimpeded Russian exports, a surging USD and a broad risk-off move in macro assets over recent weeks.

The spot softening of base metals fundamentals has, for now, averted the stock out conditions that we had anticipated earlier in the year, predicated on rising demand and imports from China as it recovers from last year’s property downturn (see here).

Precious metals
Gold and silver have moved lower in line with the broad-based USD strength – while both precious metals tend to disconnect from real rates during Fed hiking periods, the relationship with the USD is more persistent. Meanwhile, both core PGMs – platinum and palladium – have declined on concerns over Chinese demand outweigh the geopolitical supply risk premium.

Bulk commodities
Iron ore remains under pressure as fresh Covid outbreaks in China as well as more gloom for the property sector highlight a precarious outlook for steel demand. Meanwhile, the coal market remains in a state of flux with an unprecedented challenge to remap trade flows as Europe seeks to replace ~50/MT of Russian thermal coal.

Food prices have reached new record highs, in nominal and real terms, with grain prices – wheat, corn and soybean – sharply higher driven by the Russia-Ukraine conflict, inclement weather, high input (energy and fertiliser) costs, shipping delays and labour shortages.

“Critically, in line with our thesis, hoarding behaviour has emerged as farmers across the world are endeavouring to secure tomorrow’s supply themselves by precautionary inventory building today. This poses further upside risks to food price inflation which complicates policy choices for central banks globally,” the MUFG analysis said. – TradeArabia News Service


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