Commodities still finding their mojo

We all know that commodities have been feeling the pinch for a while now, but lately, the decline seems to have moved at a faster pace.

Gold bars
Source: Bloomberg

The Continuous Commodity Index (CCI), which comprises 17 commodity futures equally weighted and continuously rebalanced, fell to March lows.

Chief among the falls were those of gold and crude oil, which precipitated the drop in precious metals and energy.

Gold had marked its fourth-straight week of losses last Friday, eyeing the psychological $1000 level, with prices dropping over five-year lows of $1072.35 on 20 July. Gold is down almost 8% on the year.

The current environment seems to be increasingly hostile to gold investors, with the rising USD, low global inflation, relatively high monetary accommodation as well as decreasing physical demand adding to reasons for gold’s decline. Many are expecting further declines in the yellow metal.

Oil futures also went hand in hand with gold, with WTI closing below the key $50 level for the first time since April. US inventories expanded more than expected, government data showed, which exacerbated the oversupply problem, especially when Saudi is pumping at record production levels.

OPEC produced 32.1 million b/d in June, with the largest increase coming from Iraq and Saudi Arabia. This was 2.1 million more than what the organisation said it will maintain. Furthermore, oil is priced in USD and the recent run-up in the greenback presented another pressure point for crude. It now looks like oil may move lower, with March lows of $42-$45 in the crosshairs.

The commodity rout has a knock-on effect on related currencies such as the CAD, AUD, and NOK. More so is the increasing monetary policy divergence between the commodity countries and the US.

The Bank of Canada surprised with a rate cut, while the Reserve Bank of Australia continues to sound dovish, with governor Glenn Stevens not ruling out another rate cut, if further drops in commodities heightens the risk to the economy.

Falling commodities a boost to equities?

It is however interesting to note that falling commodity prices have a positive impact on stocks. The argument for the negative correlation goes simply like this – lower inputs will improve businesses’ profitability, especially manufacturers and transport companies.

Needless to say, resource and energy companies will not be feeling the benefits. So it really depends on which equity index you look at. When I overlay the S&P 500 with the CCI, there is a clear correlation and it suggests that lower commodity costs do boost US equities.

CNBC cited an Oppenheimer’s study that when a commodity index trends lower for four continuous weeks, S&P historically gained a 0.8% in performance, compared to 0.4% in an uptrend. When you extend it to a year (52 weeks), the gap is considerably wider at 12.6% in a downtrend vs 4.6%.

However, a quick look at the relationship between CCI and ASX 200 suggested that this negative correlation does not hold for the commodity index and Australian stocks, which has a sizable mining sector.

Asia likely to see weak sentiments

The soft leads from European and US markets are expected to continue weighing on Asian markets. There is few data on the tap today, so traders may look towards the European session for clues.

Meanwhile, RBNZ cut cash rate for the second time in six weeks to 3%, while indicating that more easing is on the table if growth slows further. Governor Wheeler said that the move was needed to counter the dimming economic outlook and low inflation. Moves in NZD were fairly muted, ranging within 0.6570-0.6650, probably because the market has already priced in the rate cut.

The fact that the post-decision statement did not mention about ‘unjustified’ levels of the Kiwi, instead merely saying that further depreciation is necessary also helped stabilise the NZD.

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