Policy error and cyclical recovery to benefit commodities

The US Federal Reserve (Fed) has made a policy mistake. After raising rates for the first time in nine years, the Fed has held back from further hikes in 2016, bowing to market tantrums.

The Fed is struggling to focus on the strength of domestic fundamentals such as the strong labour market or increasing inflationary pressures and is reluctant to move too far from other central banks that are still in easing mode. Consequently central bank policy remains a supportive influence on gold. Along with the Swedish Riksbank, Danish & Swiss National Bank and the Bank of Japan, the European Central Bank (ECB) has adopted a policy of negative interest rates. We argue that NIRP, whether in nominal or real terms, is positive for gold prices. Historical data suggest that there is a relationship between negative interest rates and the gold price. Gold has risen more than 15% year-to-date and is likely to rise further as US inflation increases. A global economic recovery is likely to provide a tailwind for industrial precious metal prices (silver, platinum, palladium). Part of the reason that these industrial precious metals have been falling since 2011 is due to China’s moderating demand, as it adjusted to a slower pace of economic growth. However silver, platinum and palladium have started to recover this year, rising 17%, 18% and 17% respectively in the last 3 months and we expect demand for these metals will likely continue as China’s industrial output appears to have found a base. Furthermore, these industrial precious metals have been in a supply deficit during the past three years. 80% of platinum and close to 40% of palladium are produced in South Africa and as the Rand depreciation abates and miners cut back on activity, supply deficits for these metals are likely to grow.

• Agricultural commodities post strongest monthly returns within the complex. Corn and soybean hit multi-month highs, driven by short covering as concerns grew about the weather phenomenon, La Niña, materialising ahead of the US growing season. Lean hog futures rallied on seasonally improving demand as warm weather ushers in increased outdoor grilling.
• Industrial metals saw mixed performance last month despite a stabilisation of Chinese economic activity. Sentiment reversed course for industrial metals last month, with speculative positioning unwinding. More negative sentiment belies a continued tightening in most industrial metals markets.
• Oil has had a volatile month. Prices rose as investors expected a coordinated production freeze and then fell as no such deal could be delivered. A short-lived oil worker strike in Kuwait added further volatility. We expect declining non-OPEC production and rising global demand to lend support to prices.
• Palladium to benefit from miner capex cuts and demand for gasoline cars. While gold, silver and platinum have rallied strongly since beginning of the year, palladium is lagging behind. We believe the metal offers a catch-up potential supported by further capex cuts and increasing global demand for gasoline cars.

James Butterfill – Executive Director, Head of Research & Investment Strategy – ETF Securities (UK) Limited