Commodities ended 2016 smartly, with the Bloomberg Commodity Index up 12 percent, led by gains in crude oil, and the sector continues to show some life in early 2017.
Crude oil prices are holding at higher levels, as OPEC appears to be cutting production as it said it would. That’s expected to finally alleviate the global oil glut that’s weighed on values for the past few years. Prices for industrial metals such as copper also rose in 2016, partially on the idea that there will be greater infrastructure spending in the U.S.
Natural resource values as a whole also rose in face of gains in the U.S. dollar. That’s significant because commodities are priced in dollars and normally have an inverse relationship. A stronger dollar makes these goods more expensive for foreign buyers, too.
[See: Oil ETFs: 8 Ways to Invest in Black Gold.]
But commodity watchers say they don’t expect this inverse relationship to last for long, and a good part of commodity market returns likely will be predicated on the strength of the greenback.
“It’s unusual for the commodities complex to ignore dollar trends for much longer, given we’ve seen the bulk of the shift in speculation that has been driving prices,” says Rob Haworth, senior investment strategist with U.S. Bank Wealth Management in Seattle.
The dollar could be a weight on the broader complex this year, Haworth says, but he’s not expecting the double-digit gains the greenback enjoyed in 2015 to be repeated. Gains are more likely to be muted, he says. The dollar could find support if the Federal Reserve continues to raise interest rates as that puts it at odds with other major central banks like the European Central Bank and the Bank of Japan, which still are promoting loose monetary policy.
Gold loses some shimmer. While industrial commodities such as oil and base metals such as copper and zinc are up from their 2016 lows, the impact of the dollar’s strength on commodities is most apparent in gold prices.
After reaching a high of nearly $1,390 an ounce in mid-2016, gold is wallowing around $1,200. It’s been a reversal of fortune for the metal. Last year at this time it was one of the best performers in the financial market as buyers sought it as a hedge against worries of a slowing global economy.
But with the stock market making new highs, bond yields rising and the dollar up, gold’s role as an insurance policy is less desirable.
Roland Morris, portfolio manager and strategist for VanEck in New York, says gold is the “clear loser” to the stronger dollar.
“You saw that post-election,” Morris says. “The dollar had a pretty strong move post-election. It’s (dollar strength) on optimism of pro-growth policies from the Trump administration that created expectations of more rate hikes from the Fed.”
Haworth says commodity futures market participants shifted their positions to be more cyclical, holding positions while expecting higher oil prices, lower gold prices and are turned slightly positive on industrial metals.
Because commodities may be returning to a more traditional cycle, supply and demand factors and the influence of the dollar will likely be impacting the sector.
The only factor that might help gold is if geopolitical events heat up, which give the metal temporary strength as a safe haven, Haworth says, but he doesn’t see that occurring.
[See: 8 Gold ETFs to Buy Anytime.]
Some commodities may rise. Charles Cameron, deputy portfolio manager for the VanEck Natural Resources Equity Strategy, says he is positive on commodities.
“In the metals space we continue to like zinc, nickel and copper to a lesser degree. Crude at these levels between $50 to $60 is what you’ll see through the year,” Cameron says. “We definitely will have some commodities win and some lose, even in a strong dollar environment. If we get more growth on a global basis you can tighten up the commodity market quickly.”
If the dollar strengthens further, it will be a headwind for all commodities, Morris says.
“The reason for that is a strengthening dollar tightens financial conditions globally and creates a weaker growth outlook for emerging markets. And that’s your demand-driver for natural resources in commodities,” Morris says.
Kim Forrest, vice president and senior equity analyst at Fort Pitt Capital Group in Pittsburgh, takes a more nuanced view of both commodities and the dollar for the year.
“The dollar is important, especially for profitability of both the companies that own the assets, the people who dig the stuff out of the ground,” she says. “If that is a U.S.-reported company, it can have negative effects.”
That’s the case for companies like Caterpillar (ticker: CAT) and Deere & Co. ( DE), along with other industrial-oriented companies, she says.
However, she adds, investors need to consider a few other factors than solely commodity strength or dollar strength.
“If the economy is much stronger, they don’t call them commodities for nothing,” Forrest says. “You’re going to need them. I think that what an investor has to weigh whatever end-commodity they’re looking at, how in-demand it is and the price will rise accordingly to overcome that strong dollar.”
While she sees the U.S. economy being strong, it’s unclear at this point what a Trump presidency means in terms of infrastructure spending, which was one of the reasons for the rally in industrial metals. So far all President Donald Trump has said is he’ll spend $1 trillion on infrastructure without specifics.
[Read: 10 Commodities to Rev Up Your Portfolio.]
“If that infrastructure spending goes through like we’re thinking it’s going to be, for things like commercial buildings, airports, and such that would (use) copper, steel and aluminum. Those would be good areas to invest in, all the way up the (supply) chain.”
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Will the Dollar be a Headwind for Commodities? originally appeared on usnews.com
