How the US Dollar is Wreaking Havoc on Commodities

Well, as we enter the last full trading day before Christmas, the US dollar bull market charges on…wreaking havoc on commodity prices.

At the time of writing, Brent crude was down 2% to US$60.18 while gold was down $1.5% to $1,178. Silver was hit for 2.25% while copper was relatively unscathed, down just 0.35%.

There’s a great sucking noise coming from emerging markets. It’s the sound of dollars escaping and heading back to the US.

Russia is again in the spotlight. The Financial Times reports that it faces a ‘full blown crisis’ according to former finance minister and President Putin ally Alexei Kudrin. He reckons Russia faces defaults and the loss of its credit rating as this crisis drags on.

But markets don’t seem to really mind as they continue to reverse the losses first brought about by the collapsing oil price. The Dow finished up around 0.9% while the S&P 500 increased 0.4% for the day.

In Australia, the commodity price rout continues to have an effect. The, perhaps out of ideas at the end of the year, has a front page story saying that billions of LNG projects are at risk.

This isn’t exactly a revelation, but it names the Scarborough and Bonaparte projects as likely to join their WA counterparts Browse and Sunrise in being placed on hold during this oil price rout.

That’s probably not sounding too good to the WA state government, who will lose billions in royalties from the potential loss of these projects. I only hope that they haven’t already spent the proceeds, like they did with projected iron ore royalties.

And wasn’t that a debacle? Yesterday, the WA state government came out with some revised budget numbers in its mid-year update. The revision was desperately needed thanks to an idiotic iron ore forecast of US$123 per tonne for the 2014/15 year.

That mistake led to a $1.6 billion revenue downgrade for this financial year, while a reduction in price estimates over the next three years means budget revenues will now be $5 billion less than previously thought.

The state government forecasters may be bloodied but they are not unbowed. They still expect prices to rise in the years ahead. As in they expect prices to average levels well above where they are now, starting at $75 per tonne this year, rising to $81 per tonne in three years’ time.

Meanwhile, the official government forecaster, the Bureau of Resources and Energy and Economics (BREE) just downgraded their forecasts for iron ore to $63 per tonne…down from earlier expectations of $94 per tonne.

With all these government forecasters following the price down, we must be getting close to a bottom. Although keep in mind prices always tend to overshoot…on the upside as well as the downside.

Also keep in mind that gold could prove to be a good model for the rest of the commodity complex. That is, since peaking in September 2011, it’s been in a long and grinding bear market. This could be a sign of things to come for oil and iron ore.

Speaking of gold, the sector had a cracker of a day yesterday, with many stocks up double digits, despite the actual gold price not doing too much. The big moves were probably a combination of short covering and panicky investors looking for value in a market that doesn’t have a great deal of it.

The Aussie dollar gold price has actually done pretty well of late, and combined with a 50% fall in oil prices (one of the biggest costs for a gold miner), the economics of gold mining in Australia are probably much better than many people think right now.

But expect Aussie gold stocks to give up some of their gains today on the back of further falls in the US dollar gold price overnight. Today’s price action will be important. If the goldies can hold onto the bulk of yesterday’s gains, it will be impressive and bullish.

I’m not holding my breath though. Commodities are in a pretty nasty bear market. And as much as you might like to think that gold is not a commodity…but a precious metal instead…the ‘market’ thinks otherwise. Gold is locked into the commodity complex. It’s not going to have a sustained move higher until other commodities move higher too.

And that’s probably not going to happen while the US dollar is in a bull market…something that ‘everyone’ thinks is a sure thing into 2015. In financial markets though, sure things have a habit of disappointing. So keep your eye on the US dollar story next year. Any signs of a faltering bull run could mean it’s time to get back on the commodities story.

But we’re not there yet. As Quant Trader Jason McIntosh says, stay with the trend. Right now, the US dollar trend is bullish.

Which brings me to next year. Do we get more of the same or will something emerge to unsettle the major Western markets. For the past few years, they have shrugged everything off. That’s thanks to unprecedented central bank intervention and unprecedented belief in and acceptance of central bank actions.

I continue to think that the great risk for global markets is the disappearance of this belief…the sudden realization that central banks are just printing and hoping we all go along with it. They have no other plan.

When we reach that point, expect fireworks. But it could be six months or six years away…no one knows.

Well, that’s it from me for 2014. Thanks for reading and I look forward to another year of reckoning in 2015. 

Merry Christmas and all the best for a happy and safe New Year.

Greg Canavan,
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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