Fundamental Update: What are commodities telling us?

on January 17 2013 12:27 PM

Don’t forget that you can now follow Forex.com’s research team on Twitter: http://twitter.com/FOREXcom

Commodities have a close relationship with the dollar; most commodities tend to be priced in dollars so they are sensitive to changes in the value of the greenback. Commodities also tend to be correlated with risky assets; however, they haven’t followed equities higher since the start of the year. As a firm believer that you can’t look at one market (say FX) in isolation, I will try to explain in as simple terms as possible what commodity prices may be telling us and the impact this could have on the broader market.

Chart 1: USDJPY and Brent crude oil (generic contract)

While USDJPY has been shooting higher Brent has been stuck in a fairly narrow range in recent weeks as you can see in the chart below. Usually when the dollar is strong it can weigh on commodity prices like oil as you need fewer dollars to buy a barrel of Brent/ WTI etc. Thus, the Brent/ USD relationship has not performed as one would expect and has not had a big sell off alongside the rise in USDJPY.

Chart 1: USDJPY and Brent crude oil (generic contract) Chart 1: USDJPY and Brent crude oil (generic contract)  forex.com

Source: Forex.com and Bloomberg

 

Chart 2: Gold and USDJPY

Gold has also been range bound while USDJPY has been moving higher, however in the last few days gold has strengthened along with the dollar. As you can see in the chart below, for most of 2012 the yellow metal and the dollar moved in inverse directions. This shift is worth watching closely in the coming days.

Chart 2: Gold and USDJPY Chart 2: Gold and USDJPY  forex.com

Source: Forex.com and Bloomberg

 

What can we tell from these two charts?

1, the dollar may be strong versus the yen, but it is not strong across the board and is not strong enough to push commodity prices lower. The dollar index (the greenback versus its largest trading partners and now available to trade with FOREX.com) has actually fallen by 1.44% since the start of January.  Impact on FX: For USDJPY to have a sustained move higher we will need to see two things happen: 1, the BOJ take an extremely dovish stance at its meeting next week and pledge to reduce the value of the yen further and/ or 2, a more broad-based strengthening of the dollar. The latter seems unlikely to happen in the near-term, unless the Eurozone sovereign debt crisis flares up once more, which is always a possibility.

2, Gold has not been a bona-fida safe haven for many years, however, in this time of fiscal foolishness on both sides of the Atlantic we may start to see investors move into gold in an attempt to protect themselves from fiscal crises and central bank-fuelled currency debasement in the US and Japan.

Stocks, commodities and a little bit of inter-market analysis 

The relationship between stocks, commodities and bonds is also important for investors. You may think: “why do I need to look at bonds, I only trade FX?”, but trust me the bond market can give you very useful information about potential currency trends.

There are two things to point out:

1, risky bonds – like those of Spain and Portugal –have been gaining in value, while the value of safe haven bonds like US Treasuries and German Bunds have stalled. US Treasury yields have been trending higher since the middle of December, while German 10-year bond yields have increased by 30 basis points since the start of this year. NB: bond yields move inverse to price.

This is where Inter-market analysis, as defined by the technical wizard John Murphy, comes into play. According to this theory commodities are the most sensitive to changes in bond yields. When bond yields in the major economies like the US and Germany are rising (even from this low level) it can suggest tighter money supply in the future, which may thwart demand for commodities. Hence, this is one explanation why commodities have failed to join in the stock market rally since the start of the year.

Let’s work through an example of inter-market analysis in action: commodities feel the pressure of rising Treasury yields first, if Treasuries continue to rise then this should put upward pressure on the dollar on a broad-based basis. Eventually, stocks get hit as rising yields push up borrowing costs for corporations and a strong dollar could hit demand for exports, which may weigh on profits.

Chart 3: Brent crude oil (generic contract) and S&P 500

As you can see, commodities and stocks have been moving in opposite directions since the start of the year.

Chart 3: Brent crude oil (generic contract) and S&P 500 Chart 3: Brent crude oil (generic contract) and S&P 500  forex.com

Source: Forex.com and Bloomberg

Conclusions:

Although this analysis is far from exhaustive there are a few conclusions we can draw:

1, If we continue to see Treasury yields rise then we may see a broader rally in the dollar, which may limit the strength of USD crosses like EURUSD and AUDUSD in the medium-term.

2,The global stock market rally we have seen of late may have further to go, but gains could be capped in the medium term. Thus, we may see 1,500, maybe even 1,550 in the S&P 500 before running into resistance in the coming months. Likewise, 8,000 – one of the highest ever levels in the Dax, which is less than 300 pips away – could be an extremely sticky resistance zone for this European index.

3, Commodities could be at risk of a sell-off in the coming weeks if US Treasury yields continue to move higher. For Brent crude $105 and then $103.70 – the 61.8% retracement of the Feb high to June 2012 low – should act as key support levels. In WTI $91.35 – the 200-day moving average – then $89 – the top of the daily Ichimoku cloud – are both important support zones for US oil.

4, There are very tentative signs that gold could be attracting safe haven flows, but we need to see continued strength in the price of the yellow metal for this to be confirmed. $1,710 – the base of the daily Ichimoku cloud – is a key resistance level in the near-term for the precious metal.

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957  | e: kbrooks@forex.com| w: www.forex.com/uk

23 College Hill | 3rd Floor | London EC4R 2RT

Now you can follow us on Twitter: http://twitter.com/FOREXcom

 

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.Futures, Options on Futures, Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex and commodity futures, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan. Please read Characteristics and Risks of Standardized Options (http://www.optionsclearing.com/about/publications/character-risks.jsp).

For more forex information, go to www.forex.com

More News from IBT MEDIA