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March 2016 | Volume 18
  • Are investors too complacent about US inflation?
    ___________
    Low inflation has been an unwelcome thorn in the side of the US Federal Reserve (Fed) and remains the most elusive piece of the Fed’s interest rate puzzle.
  • Up, up and…?
    __________
    The New Year began in disastrous fashion for the oil market with Brent crude touching 12 year lows in January, which followed a year to forget in 2015.
 

Detecting an inflection? A letter from Philip Saunders

Something may be stirring in the battered and unfashionable world of commodities. At the very time when we are all meant to be weighing up the probability of a global recession, a number of the key commodities and related assets have somewhat perversely been experiencing impressive rallies. The lows in the iron ore and gold prices were made back in December 2015, since then iron ore has rallied by over 50% and gold by close to 20%. Copper and West Texas Intermediate (WTI) crude oil made their recent lows in January, with copper futures up by 15% since then and WTI rising 46% from US$28 per barrel to US$41 per barrel at the time of writing. So are these moves simply vicious short squeezes in continuing bear markets or do they signify that something fundamental has  changed?

Commodity prices have tended to be strongly inversely correlated with the US dollar, so could this be signalling that the dollar has peaked, or at least peaked for now? Although there remains a strong pro-dollar consensus, it actually hit its highs some time ago against the yen and the euro, but continued to strengthen
against emerging market currencies, many of which are sensitive to commodity price performance. These things are plainly interconnected because the dollar has been a barometer of tightening international liquidity conditions, which have
progressively undermined asset prices post the ‘taper tantrum’ of 2013. A weaker dollar would arguably herald a loosening of financial conditions, particularly in the developing world, where the scarcity of willing international liquidity has had increasingly painful domestic consequences.

Commodity price stability, let alone sustained rallies, would presumably alleviate the prevalent deflationary concerns. Bond yields would retreat from their lows and there would (thankfully) be much less chatter about central banks having ‘run out of ammunition’. It seems unlikely that inflation is set to run away on the upside, but a retreat from unorthodox monetary policy would be a net positive development, albeit an uncomfortable one for developed market bond investors.

What about equities? Could the recent volatility and natural resources stock rally be signalling a change of leadership in stock markets? Has the divergence between ‘growth’ stocks and cyclicals simply gone too far? The price action in gold mining shares, which are up close to 50% year to date, is intriguing because there were evidently no sellers to be found, which is often a good indicator of a cyclical inflection point. Emerging market equities themselves tend to be highly correlated with commodities and it is interesting to note that they too have outperformed their developed market counterparts so far this year, which again indicates that investor positioning is already extremely negative.

Straws in the wind maybe, but if they turn out to be more than that the implications for portfolio positioning would be profound.
 

Philip Saunders
Co-Head of Multi-Asset


"Could the recent volatility and natural resources stock rally be signalling a change of leadership in stock markets?"

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