Commodities fired up by fading dollar

  • Investors flock back as commodities march higher
  • The dollar is weaker and oversupply is reducing
  • Gold and silver sparkle as the first quarter's star performers
  • Mild weather makes natural gas buck the trend big time
  • Wealthy Chinese gamblers proved a disruptive influence



The Bloomberg Commodity index has rallied by almost 18% since hitting a 17-year low back in January. The strong rally has attracted investors back into an asset class which for the best part of five years had been out of favour. Oversupply of key commodities especially oil has started to be reduced with the 19-month selloff forcing a reduction in output from high cost producers while attracting demand.


For the year, however, the precious metal sector remains the winner. Fading expectations of further US rate hikes amid weaker growth, a prolonged dollar selloff and negative bond yields have triggered an investor surge back into metals. While gold attracted most of the demand during the first quarter, April belonged to silver. 


Since early March the demand for silver through exchange-traded products had surged. It was not until early April however that the price finally broke its shackles to gold and surged higher. The past month has seen silver rally by 16% and against gold the ratio has fallen from 80 back down below 72. 


Natural gas under pressure from milder weather and ballooning inventories went against the positive trend this past week. 



While some of the commodity rally seen in the past couple of months have been due to changing and supportive fundamentals, we have also witnessed a great deal of disruption. During the past month, China's commodity exchanges increasingly began resembling an onshore Macau. An army of private investors in China looking for somewhere to invest excess cash or just gamble got more and more involved in highly volatile commodities from iron ore and steel to coal and cotton. 


These contracts have been some of the most heavily traded in the world this past month with the traded volumes in steel on some days overtaking that of crude oil benchmarks such as WTI and Brent crude oil. Worried about a repeat and disruptive bubble similar to the one seen in Chinese stocks last year saw Chinese regulators stepped in to curb trading. Steel which up until the announcement had rallied by 27% dropped by 7% before surging higher Friday. 


Increased speculative demand in commodities which only have a finite amount of supply and demand raises the risk that prices can move too far away from levels supported by underlying fundamentals. Some examples of the recent craziness:

  • Dalian Iron ore futures volumes exceeded China's annual import on several days. 
  • Shanghai steel futures one day eclipsed all the shares traded on China's equity market
  • Cotton traded enough volumes in one day to produce 9 billion pairs of jeans
  • Average life of an Dalian Iron ore trade is 4 hours, compared with 40 on WTI crude


Large speculative positioning is not only a Chinese phenomenon. We have seen a strong build up in speculative bets on crude oil, gold and silver to mention a few. Fundamentals in our opinion continue to support precious metals. The record long, however, currently building in oil futures, especially Brent crude, will increasingly pose a risk should the current positive outlook change.


Investors' current love affair with precious metals was given an additional boost this week. The lack of action from the Federal Open Market Committee and the Bank of Japan helped drive both the dollar and bond yields lower. The continued dovish stance from the FOMC was followed up by a weaker-than-expected GDP reading for the first quarter. The combination of these developments gave gold and silver enough momentum to revisit recent highs. 


Platinum, another metal with a dual purpose like silver (investment and industry), found strong support at $1,000/oz before rallying to reach $1,065/oz, the highest level since last July. Just like silver, platinum have been outperforming gold and during the past few months its discount has contracted from 26% to 17% currently. However, it's still well outside a five-year average discount of less than 2%.


While gold received most of the attention during the early parts of the year April belonged to silver. A surge in investor demand, both through futures and exchange-traded products, saw the price finally break its shackles to gold. The past month has seen silver rally by 16% and the gold/silver ratio has fallen from above 80 towards first key support at 70. 


The gold/silver ratio has seen a dramatic drop this April with support at 70 likely to curb further advances in the short term.


As seen on the chart below gold has now returned to the higher end of the range that has prevailed since February. During this time investor have been left frustrated, both from its ability to find support above $1,210/oz which have forced latecomers to the rally to chase the market. Bulls meanwhile have also been frustrated by gold's failure to keep up with surging silver and platinum. 


As we see the gold/silver ratio approach support at 70 we would once again favour gold over silver, both from the expectation that a continued rally in silver will be difficult without the support from gold but also as an insurance policy should the rally once again run out of steam. During a correction silver is likely to take a bigger hit than gold. Not least considering the speculative net-long positioning which has reach record levels.


Gold has been range bound since February but now once again challenging resistance at $1,285/oz.




Strong investor demand, a weaker dollar, and expectations of lower production has propelled crude oil to a new high for 2016. While WTI crude has breached $45/barrel, Brent crude has now moved within striking distance of $50/b.


We see oil trade higher towards year-end but are increasingly concerned that the current rally is too much, too soon. The latest run up in price has increasingly being driven by speculative traders more than fundamentals. As we approach $50/b, we will begin to read stories about high-cost producers coming back to life and this, combined with the overhang of more than one billion barrels in storage across the world, could delay the rebalancing process.


Apart from another weekly decline in US production the weekly inventory report provided little in terms of support. But as a testament of the current strength and momentum the oil price finished the day higher following an initial selloff. 


Don't fight the trend is the best advice one can currently give and we say to those looking for a downside reaction to use options at this stage. Crude oil is now in a much better place but as the rally continues we will see increased worry that a prolonged rally could be self-defeating. 


The rising speculative interest in oil also poses a threat to the health of the rally as it is leaving it exposed to a sharp turnaround should the focus or fundamental outlook change. The combined net-long of Brent crude and WTI crude futures have now reached 655 million barrels. The previous peak of 626 million barrels was seen in June 2014 just before the selloff began. 


Brent crude extending its rally after finding support above $44. It has now rallied by 20% since the failed Doha meeting on April 17. 



Ole Hansen is head of commodity strategy at Saxo Bank. His Twitter account was cited by MarketWatch as one that investors should follow in 2016.


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