Commodities | Jun 07 2013
-Rising US yields heralds US dollar turnaround
-US investors are not buying offshore
-US dollar move not fully translated to commodities
By Eva Brocklehurst
The US Federal Reserve chairman's remarks has always been scrutinised for the minute changes to policy that may be implied. It may be embryonic but the market senses Ben Bernanke is getting ready to adjust the levers. The implications are significant. The US economy is showing signs of improvement after a long period in the doldrums. This suggests ultra low US interest rates cannot persist and once yields start rising in the US they only need to narrow the gap enough to attract global money, as funds readily move into the haven of historical choice, the US. Such movement of funds will whittle away the down-trend for the US dollar. That's the simple part.
The situation is aggravated by the fact that other major economies, such as Australia, are still in easing cycles, underpinning the US dollar appreciation. Commonwealth Bank analysts suspect this divergence in the policy cycles is reducing the incentive for diversification away from the US dollar. A number of central banks may also be increasing their US dollar reserves in response to more attractive US real yields. Of note too, for only the second time since 1973, US residents have stopped the regular flow of large-scale investment into offshore equity markets. It is likely the relatively better performance in US equity markets, and the drawn out European recession, has encouraged a reversal in the typical pattern. This reduces the amount of US dollar selling and delivers a net US dollar buying outcome.
The complexity is compounded when deciphering what such a change in the trend of the US dollar means for commodity prices. A stronger US dollar should lead to weaker US dollar-denominated commodity prices but the relationship is circular. Softer prices encourage more demand and stockpiling. Demand can push prices back up when supply bottlenecks occur, or global production of that particular commodity is impaired for whatever reason, hence the stronger US dollar does not fully translate into weaker commodity prices. Key to this is that a strong US dollar alleviates the cost pressures for the significant amount of mining costs that are incurred in non-US dollar currencies. That helps justify production rates, or even improve them. So it goes.
Other currency pairs also have an impact. In this respect, the analysts observe that US GDP growth is outpacing the G6 average. The analysts suspect this has some way to run. The US dollar/Japanese yen is rallying, driven by the structural collapse in Japan's current account surplus. The analysts note that, since 1977, large directional moves in the US dollar/yen are consistent with the direction of the US trade weighted index. This is now more complicated. The US current account deficit has sustained a decline in the energy deficit, led by a reduction in energy imports, but this is offset by an increase in the non-energy deficit. Thus, the deficit as a percentage of GDP has stayed around 3% for the last four years. The analysts believe it will be some years before the trade deficit structurally improves and therefore the US dollar won't get support from that quarter.
Commonwealth Bank analysts have revised down most metals, energy and bulks commodity price forecasts for FY14 and FY15. Exceptions include expectations for mineral sands, with rutile price forecasts revised up 2% in FY14, reflecting stronger demand for higher grade titanium dioxide.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
