Talking Points
- The Bloomberg Commodity Index has dropped to a 16-year low
- A range of commodities are near meaningful support, but few are as prominent as oil and gold
- Weak economic growth forecasts, a strong dollar and an expected rebound in yields are contributing
See how retail traders are positioning in the majors in your charts using the FXCM SSI snapshot.
Among a range of asset classes with an innate sensitivity to ‘risk appetite – whether directly or otherwise – the worst performer is commodities. Lacking for income-type returns, priced against a strengthening currency and facing disappointing forecasts for global economic activity; there is significant fundamental wind working against the market. The question going forward is how much bleeding commodities have to suffer? Would a risk aversion move that further sinks higher-brow speculative assets further drive natural resource prices lower? And, what particular raw material will anchor the view for the group?
The Fundamental Winds
For an overview of where the commodity market is today, we can look at any number of indexes that offer an overview of both ‘soft’ (typically grown) and ‘hard’ (mined) natural resources. The Bloomberg Commodity Index is one of the more comprehensive and it is extended its drop to fresh 16-year lows this week.
How far these momentum extends will depend on a range of fundamental factors. The most logical motivator for prices boils down to the academic supply-and-demand. Consumption of these goods is associated to economic health. And, given the downgrades in growth projections from individual countries governments and central banks as well as the aggregate downgrades by groups like the IMF, the winds are unfavorable. Below is US GDP versus US (WTI) oil prices. The US forecast is seen leveling out, but other developed and developing countries are still revising their views down.
A second consideration for commodity’s value slide – and probably the most prominent drive for future declines – is the common instrument used to price the goods: the US Dollar. The Dow Jones FXCM Dollar Index surged to a 12-year high this past Friday after October NFPs upgraded market rate expectations. As the US nears and passes ‘liftoff’, the currency’s strength will intensify and in turn devalue the physical goods that it can afford.
A third factor that is target to specific commodities is the implication of a changing monetary policy era. While central banks like the BoJ and ECB are still pursuing Quantiative Easing (QE) programs while others like the PBoC are following more traditional lines, the limitations to large asset purchase programs is in view. The Fed is set to be the first mover to a tangible change from a dovish drive with a rate hike, but as other aggressive bodies ease back; the collective expectation will be for higher returns in financial assets that draws interest away from commodities that don’t offer ‘income’.
The Key Players
Grains, the energy complex, industrial and precious metals, and most commodities are under pressure. However, there are a few natural resources in particular that stand to draw the market’s focus/ire as key technical thresholds are passed and their fundamentals top the headlines.
Crude oil is one of the most prominent of the commodities among the speculative, regulator and industry ranks. From a technical perspective, US oil has dropped six straight days through Wednesday’s close to match the longest slide in 15 months. The subsequent technical floor comes in around $42.50/43.00 which would represent a three-month low.
Oil represents the heaviest component in many commodity indexes and is one of the most important natural resources in the world. As such, the attention it will be afforded as a benchmark for the broader asset class will be the most intense. Crude in particular has a stronger connection to supply-and-demand factors through global growth forecasts (one of the IMF’s major downside risk concerns) and through the glut fostered by diminished revenues across OPEC and non-OPEC producers. If this balance changes, it could carry surprising influence over other, even-unrelated assets.
From a positioning standpoint, retail speculative traders are very certain that relative support will hold. According to the Speculative Sentiment Index from FXCM, there are 4.5 longs per every 1 short held by traders.
Gold in contrast to oil carries less importance for the ‘growth’ view of the market, but it is a crucial reflection of more economic and financial measures. Its role as an inflation-hedge, safe haven and anti-currency are well known. That being said, the precious metal has plunged this past month. After working through months of recovery, the topple from mid-October brings the metal within sight of five-plus year lows. This is even more significant a technical waypoint as it represents the mid-point of the historical range for the market that stretches back decades. The line in the sand is seen around $1,085.
What is perhaps more remarkable than the relative technical level gold finds itself at is the intensity of the decline that brought it to this cliff. Over the past month (20 trading days), gold prices have dropped 17 sessions. That is the most intensive bearish pressure on the commodity on records going back to the gold standard.
After such a remarkable drop and given the proximity of substantial ‘support’, there will be a strong speculative debate as to whether the market holds or extends its momentum to a crucial break. Putting the question to traders on Twitter. The consensus leans towards a hold. According to the survey of nearly 241 people, 43% expect Gold to break and carry through below $1,000 by year’s end. Therefore, 57% expect it to hold above the mark on December 31.
Looking at positioning, the expectations are a little more intensive for the near term. According to the SSI, retail traders are long 2.7 times the number of shorts they hold. Of course, a bounce can stall out and the mix quickly change on a second approach.
