The return of the commodity kingdoms

5:38 AM | February 2, 2016 Sektoral No Comments



We’re standing at the crossroads between crashing commodity prices and a derailment to their long-term price trajectory. Commodity prices across the board have shown dramatic rebounds from the massive sell-off, led by crude oil prices, which rebounded c.25% from the low. With commodity prices reversing trend, emerging markets would benefit the most, as they are the major global suppliers.


The Fed is not well-fed

In our Daily Focus notes, we emphasized the Fed’s latest views being the flipside of previous policy. The Fed is aware of slowing economic growth despite full employment, and now they’re closely monitoring global economic and financial developments. Furthermore, we also note that the Fed is starting to become aware that inflation will not meet their long-term target. The Fed’s ‘must-hike’ stance seems to have shifted to ‘will see later,’ which would lower investor confidence in holding US dollars. This was confirmed by the weakening of USD/IDR, Dollar Index (DXY) and the Bloomberg Dollar Index (BBDXY) after the latest Fed meeting (see Figure 1). With a weaker dollar, the free fall of commodity prices across the board should react like a bungee cord. This is confirmed by the relatively inverse relationship between the DXY and the Bloomberg Commodity Index (BCOM) over the last 10 years (see Figure 2). Looking to the latest softening by the Fed, we believe the Fed will not be able to raise their full-year rate 100bps, as the market estimated. Hence, the end of the super-dollar trend could temporarily result in a reversal of commodity prices.


First (possible) cut by OPEC

Last Friday, one of the most discussed topics was Russia’s statement that OPEC had proposed an oil production cut of up to 5 percent in what would be the first global deal in over a decade to help reduce supply and prop up crashing prices. The recent oil price crash was supported by oversupply, as the supply-demand gap widened in 2015 (see Figure 3). If Russia’s statement turns out to be true, a 5% crude oil production cut by OPEC will narrow the supply-demand gap, thus propping up prices. Crude oil, as the ‘leader’ of commodities, could help higher commodity prices if its price is expected to rise.


The rise of commodity kingdoms

Emerging markets (EMs) are well-known as producers of the world’s commodities. Factoring in all of above, we see the Jakarta Composite Index (JCI), MSCI EM, and BCOM responding positively to the Fed’s softening stance and probable OPEC production cut (see Figure 4). We note that the strong foreign net-selling trend in the JCI from the beginning of the year has reversed course in the past three trading days (see Figure 5). As these trends continue, we believe this could be the beginning of the return of the commodity kingdoms.