Attractive fundamentals trump fragile risk backdrop

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Uncertainty over the US Federal Reserve (Fed) policy, risks of the UK exiting the EU, a China slowdown and a lacklustre earnings season in developed markets have all contributed to greater volatility in asset classes.

We continue to expect further weakness in the US dollar in the coming month, primarily due to the temporary weakness in the US economy and market volatility increasing the chances of the Fed not acting in the June FOMC meeting which occurs 8 days before the UK referendum.Despite recent disappointing news from China, which consumes 40% of global industrial metals, we expect commodity demand from the country to continue to grow in the region of 8%. Regardless, due to the growing evidence of supply-side destruction, sentiment has risen to levels not seen since early 2014. We continue to see a compelling case for industrial metals. They demonstrate the widest gap between marginal cost and current prices. Miner’s capital expenditures are continuing to fall for a fourth year while supplies remain broadly in deficit.Prices have rebounded across the energy sector over the past month, with double digit returns accruing to both WTI and heating oil. Historically, there appears to be no discernible seasonal oil price boost resulting from the summer driving season where demand for distillates rises. Accordingly, with prices at the top end of recent ranges, a fresh catalyst will be required to lift prices further, with supply remaining elevated globally.The National Oceanic and Atmospheric Administration (NOAA) raised their forecast for a La Niña to 75% starting this Northern Hemisphere Autumn. This suggests a much greater crop supply broadly for agriculture commodities.

  • Many agricultural commodities have seen their price increase a consequence of the El Niño weather phenomenon. The opposite weather phenomenon (La Niña) is expected to arrive in Northern Hemisphere winter, which could see the production of many crops improve in the 2016/17 harvest year.
  • The broad industrial metals complex posted negative returns in May as a firmer US dollar and rising stocks weighed on price. Judging by speculative futures market positioning, investors are increasingly pessimistic about industrial metals.
  • Oil price range between the US$45-50/bbl could be under threat if inventory drawdown can’t be sustained. Indeed, despite Canadian and Nigerian production outages, the US EIA has warned of ongoing build-up in stockpiles.
  • A fragile macro-economic environment remains supportive for gold. Investment demand for gold in the 1st quarter posted its 2nd highest quarterly figure ever. Palladium prices have recovered primarily due to short covering as fundamentals remain supportive for long term prices gains.