It's hardly a virtuous circle: select commodities - mainly in the energy and food complexes - continue to roar to one record after another, on the back of a fragile dollar, increasingly poor statistics on business conditions across the world, and ongoing evidence that credit markets remain constricted. How are the dots connected?
Oil prices may now be causing genuine damage, and increasingly maintain inflation in global headlines. Beyond the continued rotations of global portfolio flows into mainly select energy and food futures, investors also continue to also push flows towards selected commodity indices and exchange traded funds (ETFs) that imitate broader flows into traditional commodity futures.
In the past few days, fresh record prices have been posted by the likes of the S&P GSCI Enhanced Index, the S&P GSCI GFI-Futures Index, the Reuters/Jefferies CRB Index, and a good number of ETFs, such as the iShares GSCI Commodities. Many commodity prices beyond select energy and food futures have also recently moved up sharply, not least gold.
The dots are connected to the extent that investors are buying commodity assets perceived most likely to hold their value during a period of strongly rising inflation. The ongoing portfolio flows into select, but substantial, parts of the overall commodities complex are now looking like the real deal, the buzz words increasingly heard in trading pits.
With inflation again rising as a dominant theme in global markets, it is increasingly apparent that central bankers have all but officially agreed there's no single or simple way to tame inflation and also boost economic growth.
Says one London metals trader: The dollar ends the first half of the year far weaker than analysts had generally expected six months ago, although the green shoots of recovery may yet eventually sprout during the second half. Those wanting to know why the dollar's 2008 half-time report card makes bleak reading need not look far. Heavily slashed US interest rates, signals that the European Central Bank may boost rates, and a prolonged fallout from the global credit crisis make grim reading. In fact roaring inflation, collapsing businesses, constricting credit, this has the feel of the real deal.
The Bank Credit Analyst has noted that the while the euro/dollar exchange rate and the price of oil have moved in lockstep over the past year, oil also has constructive supply and demand fundamentals which in fact have little to do with currencies. BCA Research argues that the rise in energy prices has undermined the dollar versus the euro in at least three ways.
First, the European Central Bank has been more hawkish than the US's Federal Reserve in the face of oil-related stagflation risks. Second, there are concerns that Middle Eastern oil-producing countries will abandon longstanding dollar pegs as their economies overheat and inflation moves into double digits. Third, the US economy is more cyclically fragile than its euro area counterpart, meaning higher oil prices present a greater risk for US growth.
These factors, argue BCA Research, are seen as possibly explaining why the dollar has not risen much in the face of a massive upward shift in US interest rate expectations. The Federal Reserve faces a quandary: the US economy has reached a point where increases in energy prices are inflicting serious damage with relevant commodity prices apparently at choke point levels.
If the Federal Reserve hesitates in raising policy interest rates going forward, US Treasury bonds are going to sell off, inflicting damage beyond that increasingly seen across equity markets. Amid the turmoil, perhaps the most painful issue is that specific commodities and select commodity indices are increasingly seen as bullet proof. Sooner or later, something has to give.
SELECTED INDICES, SPOTS & FUTURES
S&P GSCI Enhanced
S&P GSCI GFI-Futures
Baltic Dry Shipping
Baltic Capesize Shipping
Dollar Index Spot
NYMEX sweet, light crude
NYMEX sweet, light crude
Natural Gas (US)
Heating Oil (US)
Thai white rice
Rough Rice (US)
MSCI New Zealand
MSCI South Africa
Dow Jones Industrial