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Commodities see-saw amidst geopolitics and rising yields
- Published on 04/30/2018
If there has been one theme driving global markets over the past month it has been geopolitical risk. At times, the focus has been on the potential for a trade war, primarily between the U.S. and China, but also potentially touching on adjustments to North American Free Trade Agreement (NAFTA). Subsequently, the focus has shifted away from trade policy and back towards the powder keg in the Middle East. While Syria is the headline issue, tensions between the U.S. and Russia are the true foundation.
Commodities have responded over the month. As of April 20th, the Bloomberg Commodity Index had delivered a Year-To-Date (YTD) total return of approximately 2.4%. Over the month of April, this Index was up 2.8%, thereby taking its return from negative YTD territory to positive YTD territory. When the Middle East is in focus, energy and oil historically tend to come to the forefront. On 20th April 2017 (1-Year ago), the price of one barrel of Brent Oil was $ 52.99. Now, it is nearly $ 74, rising from approximately $ 70 during April 2018 alone. Tension in the Middle East has historically been supportive to oil, but we caution investors to overplay that thesis as the production from the U.S. Shale producers has been a factor growing in its importance and may create further supply in this market.
One year ago, the price of gold was at about $ 1280 per Troy ounce, while as of 20th April it was about $ 1340 — driven upward and supported by geopolitical risk more than any other factor. We would also point out that, since commodities are priced in U.S. dollars, movement of the dollar is playing an important role. Over the prior year (20-April-2017 to 20-April-2018), the dollar weakened against all of the G10 currencies. The euro was the biggest gainer — appreciating 15.2%, while the yen was the smallest, gaining 1.7%. Over the month of April 2018, the dollar’s performance was more mixed — the Swedish krona, Japanese yen and Swiss franc actually weakened while the Canadian dollar and Norwegian krone strengthened. The euro and the British pound appreciated slightly over this short period.
- Cocoa and sugar follow different paths however, we expect sugar prices to recover. Unfavorable wet weather conditions coupled with healthy grinding figures in Europe and Asia contributed to cocoa’s strong price appreciation last month. While sugar a prices lagged behind owing to the ample supply situation. We expect the substitution of sugar production for ethanol by Brazil to pave the way for a price recovery.
- Industrial metal prices rebounded from last month’s slump, reflecting easing fears of an escalation in the global trade war. This was accompanied by speculative rallies in aluminum and nickel, both of which saw double digit price increases as a result of US trade asanctions being imposed on Russian metals producers.
- Oil prices rose by close to 10%, to the highest level since 2014. Geopolitical risk has put a premium into oil prices. If sanctions are placed on Iran and Russia, oil supplies could be disrupted, tightening the market further. Outages from Venezuela have already reduced production from OPEC more than the group had intended when they decided to curb a production at the end of 2016.
- Precious metals benefit from ongoing trade tensions and geopolitical risks. Gold appears to have fulfilled its purpose as a safe haven asset. Geopolitical risk continued to weigh on market sentiment, supporting the price of the yellow metal. Silver was the best performer in the sector rising on the back of strong fundamental data releases.
Please find ETF Securities' Commodity Monthly Monitor for Apr / May 2018 with charts on the left.
Cocoa was the best performer amongst agricultural commodities, rising by 7.1% over the prior month. Unfavorable wet weather conditions in the Ivory Coast, the leading growing country, are feared to disrupt the harvesting season which is currently underway. The change in a weather conditions are having a pronounced impact on prices as sentiment shifts. The European Cocoa Association (ECA) reported, record high cocoa grinding in Europe up 5.5% in the first quarter over the prior year owing to the high grinding margin. Grinding data in Asia posted the highest figure since records began in 2011. This is also lending buoyancy to cocoa’s price appreciation.
Sugar’s weak price performance can largely be attributed to the ample supply situation on the international sugar market, largely from EU and India. Sugar has staged the weakest performance amongst all major commodities since the start of the year. In response to its price gap with ethanol (that attained a five year high in March), producers in Brazil have more incentive to switch production from sugar to ethanol in the 2018/19 crush. According to JOB Economia e Planejamento, a consultant firm specialized in sugar and ethanol, Brazilian sugar a exports in the 2018/19 season currently underway is expected to decline by 6.5 million tons • over the prior year owing to lower processing. The resulting lower supply from the world's largest sugar exporter should support a price recovery for sugar.
Industrial metals rebounded from last month’s slump, outperforming all other commodity sectors as cooling Trump trade rhetoric soothed investors' nerves about an escalating global trade war.
Copper was one of the key beneficiaries of improving investor sentiment, posting gains of 3.5% over the prior month. Though prices remain vulnerable to trade tension tantrums, global growth conditions remain favorable, and any signs of a potential US-China trade agreement could present a catalyst for copper prices to retest recent highs.
Leading the industrial metals sector was aluminum, with prices rallying by over 20% in response to US sanctions imposed on Rusal, the world's second largest aluminum producer. This could leave almost 6% of global aluminum supply cut off from commodity markets. The threat of a potential widening of sanctions to other Russian metals producers also provided an initial boost to nickel, reinforcing investors ’already strong appetite for the base metal.
With Organization of Economic Co-operation and Development (OECD) inventories of crude oil now falling close to a five-year average, Organization of Petroleum Exporting Countries (OPEC) seems very close to have accomplished its stated mission. However, a large part of the group’s production decline has come unintentionally from Venezuela’s production outages. Global supplies could get even tighter if sanctions are placed on Iran and Russia. We believe it is unlikely that sanctions would be placed on Russian oil exports given the importance of these supplies in Europe. However, the political will-power from the US to put pressure on Iran appears very strong and so we are reluctant to dismiss the risk of tighter sanctions against Iran. For now, we have what appears to be a geopolitical premium in oil price. If geopolitical risks dissipate, we could see prices fall.
Positioning in both Brent and WTI futures is looking stretched. A decline in the geopolitical premium, could trigger a sharp downward movement in prices given the extent of positioning.
Carbon prices continued to rise, posting a 13% gain last month (72% over the past 6 months). With European Union emissions having risen for the first time in seven years in 2017 on the back of higher industrial activity, we could find companies short on emission allowances if the trend continues. Brexit had cast doubt on the EU Emissions Trading System, and weighed on carbon prices in 2017, but last month, the British Energy Minister said that the UK will continue to participate in the system until the end of the current phase (2020). That lent further support to the recent carbon rally.
Gold appears to have fulfilled is purpose as a safe haven asset. Geopolitical risk continued to weigh on market sentiment, supporting the price of the yellow metal. Ongoing trade was rhetoric between the US and China, deteriorating relationship between Washington and the Kremlin, as well as tensions in the Middle East should remain important drivers for short term price movements over the coming months. However, the yellow metal gave up some of its gains at the end of the month on the back of a strong appreciation of the US dollar.
Silver has been the best performer in the sector over the last month. Good fundamental data releases helped an initial rise in price. According to the Silver Institute, industrial demand rose in 2017, for the first time since 2013. On the production side, mine supply decreased for a second year. The price rebound has probably been magnified by an investors covering elevated short positions. Net speculative shorts in silver futures, reached a record high on April 17, right before a sharp spike in the metal price.
Platinum prices appear to have been range-trading for almost 18 months. Once again in April, it got close the $ 900 support level, before rebounding slightly to post a -2.1% performance for the month. Platinum is an essential material for the production of autocatalysts, thus short term performance is directly impacted by the potential for trade war, as car parts would likely fall into tariffs implementation.
Investors appeared to have turned extremely bearish on soybean oil, as net long positioning declined by 76% over the past 3 months. Short positions have widened by 290% since September 2017.
Net long speculative positioning surged for nickel and copper (LME), rising 82% and 81% respectively. The extent of investor bullishness reflects stronger expected global appetite for both metals.
Positioning in Brent oil futures rose 29.5% to all-time high of 503,023 contracts net long (as of April 17, 2018), which is more than 2 standard deviations above the average for the last five years. With positioning so stretched, we could see sharp downside price movements if anything were to trigger a sudden change in sentiment such as a reassessment of geopolitical risk.
Silver spent most of the first three weeks at the lowest net positioning in history. Despite bullish fundamentals, speculative market participants remained overly bearish in aggregate. This lead to a spike in silver prices on the 18th of April, as short positions were covered following an initial upward move.
In the latest report by the US department of Agriculture (USDA), soybean stocks expected at the end of 2017/18 season have been reduced more sharply than expected by the market owing to the large 7 million ton downward adjustment of the Argentinian crop.
LME copper inventories reached their highest levels since 2014, rising 67% over the past three months. This surge hints at potential weakness in global demand since the turn of the year, even as Chinese Q1 GDP growth surprised to the upside at 6.8%. Given recent strength in copper prices however, demand is clearly expected to pick up again over the coming months ahead.
Natural gas inventories continue to remain lean for this time of year. Inventories have declined 43.4% in the past three months, as cold weather has drawn on supplies for heating needs.
Live cattle futures have the steepest backwardation, providing a roll yield of 15.1% driven by softening demand and ample cattle supplies. Meanwhile lean hog futures have the steepest contango, providing a negative roll yield of 9.8% driven by an anticipation of seasonal tight supplies as warm weather usher in increased outdoor grilling.
Most agricultural commodities, with the exception of cocoa, soybean and cotton, are in contango. Negative roll yields run as high as 2.3% and 2.9% for corn and wheat respectively.
The front end of the cocoa futures curve has moved from contango into over the past month yielding a positive roll yield of 0.7%.
Both Brent and WTI futures curves are in backwardation. Brent offers the most pronounced positive roll yield: 1% between the front and the next month future. Curve backwardation has been seen as an important tenet of OPEC’s strategy to drain excess oil inventories as it discourages traders from storing oil in the hope of higher prices in the future.
Cocoa prices are trading 29% above their 200-dma on the back of unexpected wet weather conditions and robust first quarter grinding data in Europe and Asia. Meanwhile sugar prices have trailed behind and are trading 13% below their 200-dma, a price recovery is likely to follow if Brazil produces lower sugar.
Nickel’s ongoing rally has left it trading significantly above its 200-dma by 22%. We expect the positive momentum to continue owing to long-term growth trends such as vehicle electrification, and ongoing supply deficits.
Brent and WTI crude oil benchmarks are trading over 20% above their 200-day moving average, highlighting the very bullish momentum behind oil at the moment.
Platinum is trading below its 200-day and 50-day moving averages. Should prices maintain their current level or go further down, the 50-day moving would quickly dip below the 200-day indicator, highlighting the ongoing downward trend.
Unintended effects of US-China trade tensions
- Published on 04/27/2018
Tensions between the US and China over trade tariffs are growing - and this may create a friendlier picture of trade dynamics, said Patrick Zweifel, chief economist at Pictet Asset Management.
Trade policy talks between Trump and Xi: lucky in bad luck?
The gap between exports and imports in China's trade relations with the USA is greater than ever before (see Fig. 1 below). With this argument, President Donald Trump is raising import tariffs on Chinese goods.
This move has undoubtedly created tension between the two countries, but a positive side effect, in our opinion, is that the Chinese service sector could open up to foreign participation more quickly. China has promised to further open up its economy - and above all to accelerate property reforms in favor of the country's financial sector. The implementation should take place within a few months, which could avert a trade war.
Fig. 1. Bilateral trade between China and the USA (in USD)
Source: Pictet Asset Management, CEIC, Datastream, 02/28/2018.
* January and February dates combined to accommodate the Lunar New Year.
Overall, however, it is unlikely that Trump's plan to drastically increase tariffs will reduce the US trade deficit with China. The USA simply cannot manufacture the goods itself, which are currently being imported cheaply from China, at least not in the foreseeable future. For now, the US will have to keep importing these goods and higher import tariffs make them even more expensive - which in turn would drive inflation higher.
How are Trump's trade plans affecting other emerging economies? Argentina and Brazil
Economist Anjeza Kadilli has just returned from Argentina and Brazil, where she met with politicians.
In her view, Brazil and Argentina could be the big winners in trade tensions between the US and China. Brazil and Argentina already account for a large part of soybean exports to China. Their share will increase even more if China decides to stop imports from the US. This new pattern would create opportunities for investors not only in agriculture but also in related industries such as manufacturing, infrastructure and engineering.
One obstacle, however, is that Brazil and Argentina currently have the highest import tariffs (14.1% and 14.3%, respectively, excluding agricultural products) and a rather closed economy (see Fig. 2).
Fig. 2 Import duties and openness to trade in emerging countries
Source: Pictet Asset Management, CEIC, Datastream, March 31, 2018
In the talks Anjeza Kadilli had on her trip, there was a great willingness - especially in Brazil - to lower tariffs, even if this was only done unilaterally. Politicians would then direct domestic production to segments with real added value (e.g. agriculture) and lower tariffs in areas where the country cannot compete with foreign countries (e.g. industry). This development would have a positive effect on the efficiency of these markets.
Find out more about the new opportunities that thriving trade within Asia is opening up.
Read more about emerging markets:
About the author
Patrick Doubt joined Pictet in 1997. He is the chief economist at Pictet Asset Management. Before moving to this role in 2009, he led the Macro Research Team at Pictet Private Wealth Management. There he was responsible in particular for emerging markets and Japan as well as the development of quantitative models for the most important asset classes, mainly exchange rate models. Before joining Pictet, he was a research assistant in the field of econometrics and money market theory and participated in international research projects for the World Bank and the European Union. Patrick Doubt holds a PhD in econometrics from the University of Lausanne.
Pictet Asset Management is an independent asset manager with EUR 151 billion in assets under management that we invest in stocks, fixed income, alternative investments and multi-asset products for our clients. We manage individual mandates and mutual funds for some of the largest pension funds, financial institutions, sovereign wealth funds, financial intermediaries and their clients worldwide.In our investment-based business, we take a long-term approach with a unique customer focus. Our goal is to be the preferred investment partner for our clients. We give them our undivided attention, offer pioneering strategies and are committed to excellence.
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The amazing rush for new elections in Turkey
- Published on 04/26/2018
by Amalia Ripfl, Senior Fund Manager at Erste Asset Management.
Last week, the political class in Turkey surprised investors again with the scheduling of early elections on June 24th. After the constitutional referendum in April 2017, which granted the newly elected president numerous executive powers, there were already many voices speculating that presidential elections would soon be possible, as these would accommodate Erdogan's desire to strengthen his power, which had become apparent in recent years. However, these thoughts and rumors were soon forgotten, as Erdogan repeatedly spoke of punctual elections in November 2019.
The situation changed last week. With perfect timing, the new election program was proposed on Tuesday by Devlet Bahceli, leader of the MHP (Party of Nationalist Movement), alliance partner of the AKP, adopted on Wednesday by President Erdogan, discussed on Thursday by the Parliament's constitutional committee and on Friday by the parliamentary one Assembly accepted. President Erdogan put forward the cross-border operations in Iraq and Syria and the crisis in neighboring countries as reasons for the early elections - which is just as stringent as any other reasons. The fact is that the elections, now in less than two months, mark the end of a process that began a long time ago.
Who will benefit from the early elections?
It is believed that President Erdogan and the ruling AKP, as well as their government partner, the nationalist MHP, appear to be convinced that the economic momentum and popularity are on their side right now, as opposed to what might happen a year from now could. In fact, the majority of analysts agree that Erdogan's alliance currently has the upper hand in elections.
There are numerous reasons for bringing the elections forward
1. The economic situation
The economy has played an important role in the success of the AKP for 16 years. As long as the AKP was able to meet the real growth targets, it won elections. The rush reflects the level of unrest over possible economic deterioration. Over the past few years, Turkey has achieved amazing growth rates (over 7% in 2017), which were supported by ultra-expansionary policies (intensive infrastructure programs, tax advantages in various sectors, credit growth). The negative aspect of the expansionary program was the constantly high inflation (over 10%) and the constant current account deficit (estimate for 2018: approx. USD 50 billion), which wanted (and wants) to be financed.
This is the flaw in Turkey's current economic policy in an environment where global interest rates have started to turn, global liquidity continues to decline, and the cost of debt is on the rise. The operating environment for companies also becomes more difficult when you consider that the corporate sector is struggling with approximately USD 200 billion in debt but receives its income in (the weak) TRY; as a result, foreign currency losses and financing costs will continue to rise.
2. Political situation
The opposition is weak (since the 2016 coup, Erdogan has used his power to neutralize his political opponents). Now the opposition hardly has time to form a strong alliance that could pose a threat to President Erdogan. In addition, the Turkish military operation in Syria has brought nationalist and populist sentiments to the surface, which gives the AKP-MHP alliance even more support.
What can we expect after the election?
Most analysts believe that early elections could lead to political stabilization. Given that the political direction (growing authoritarianism and erosion of the rule of law) in Turkey is now clear and will only be more cemented after the June elections, investors will need to focus on economic measures and their success.
Vice Prime Minister Mehmet Simsek said the early elections would improve Turkey's economic expectations: “A new five-year period is opening where we can focus on the second and third generation of economic reforms that we will launch after the elections. "
How does the stock market react?
In the last few months, the market has been characterized by increased volatility and is constantly fluctuating between risk-on and risk-off. The mood is generally rather bad, and the effect of the weak lira is a significant one. The performance of the Turkish stock market is below that of the MSCI EM Index and is currently showing a discount of more than 30% compared to other emerging countries.
Last week the market had a short-lived rally with all sectors performing well. Some investors are already assuming that the uncertainty will disappear after the elections in June. The banking sector and state-affiliated companies, which were significantly weaker than the market in the previous months, clearly outperformed the other sectors.
Macro situation continues to be above the market trend
On the other hand, the long-term scenario has not changed. Turkey will continue to occupy an important strategic position for Europe and European companies in the future. Turkish companies will continue to be run by professional management, which is efficient, flexible and business / customer / profit-oriented and promises investors strong profits. The macro situation will continue to hang above market developments (high debt, high inflation, volatile or weak currency), but expectations have now increased with regard to political measures aimed at stabilizing the economy.
The political class in Turkey is expected to become aware of the current economic imbalances, begin reforms and launch economic programs that will create a more stable macroeconomic situation and reduce the current account deficit. A more substantial increase in interest rates to control inflation and the weakness of the lira, and consequently lower GDP growth, could be the main themes for 2019.
In our portfolios we focus on quality companies with good fundamentals, high export skills and good relationships with the political class. We believe these companies will benefit most from future government incentives.
Important legal information:
Forecasts are not a reliable indicator of future developments.
This post first appeared on the Erste Asset Management blog.
You can find more information on the Erste Asset Management product range at www.erste-am.at.
A stronger euro is not an obstacle to increasing profits in Europe
- Published on 04/25/2018
The improved price environment in Europe is one of several factors that can offset the headwinds from a stronger currency, said Martin Skanberg, fund manager for European equities at Schroders.
For some market watchers, the appreciation of the euro against the US dollar was a cause for concern. They feared that this could stifle earnings momentum in Europe.
We acknowledge that the stronger currency is a drag on exporters, but we recognize numerous other factors that can support continued earnings growth in the region.
The euro has been rising for more than a year
As Figure 1 below shows, the euro has been appreciating against the US dollar for more than a year. Nevertheless, the profits of European companies have grown strongly. We also note that in 2015 and 2016 it was the other way around, that is, the US dollar was strong and the euro weak, without any increase in profits for European companies.
Figure 1: The euro has recently appreciated against the US dollar
US dollar to euro exchange rate
Source: Thomson DataStream, Schroders, as of March 8, 2018.
In our opinion, this suggests that the rate of economic growth is a more important factor in boosting corporate profits than the exchange rate.
The euro’s recent strength is a signal of a more resilient economy and the underlying fundamentals of the European economy are solid.
Although the appreciation of the euro is holding back the pace of growth in earnings per share in the euro zone somewhat, the estimates of earnings per share in continental Europe for 2017, 2018 and 2019 have been revised upwards, as shown in Figure 2 below.
Figure 2: Revised upward earnings per share projections
Weighted indexed earnings per share
Source: Schroders, Thomson Reuters DataStream, as of February 20, 2018. The graph shows the profit forecasts for the MSCI Europe ex UK Index.
Improved pricing environment for companies
What is the driving force behind these upward revisions in earnings? In our opinion, this is primarily the return of inflationary pressures in Europe. As Figure 3 shows, the producer price index in the euro zone has come out of negative territory.
Figure 3: The producer price index for the euro area is no longer negative
Change over 12 months, in%
Source: Thomson Reuters DataStream as of December 15, 2017. For illustrative purposes only - not a recommendation to buy or sell any equipment.
This reflation (higher economic growth and higher inflation) improves the pricing power of companies, which means they can raise prices without adversely affecting demand. In our opinion, the positive effect of this factor on corporate profit margins is more significant than the burden of the stronger euro.
These inflationary pressures are the main reason why we remain optimistic about earnings per share growth in the eurozone. Inflation is likely to continue to rise as capacity becomes scarce in Europe and unemployment falls. When capacity is reached, companies either have to expand to produce higher volumes or they can raise prices. When the supply on the labor markets becomes scarce, workers can demand higher wages.
However, we do not expect inflation to get out of hand and note that it is currently still below the European Central Bank's target level.
Eurozone earnings are already up 23% year-on-year, as shown in Figure 4 below. It is noteworthy that this acceleration was achieved despite the appreciation of the euro.
Figure 4: The earnings momentum has improved significantly
Year-on-year profit growth, in%
Source: Barclays European Equity Strategy. Dates reported on March 1, 2018.
If the US dollar were to strengthen again, possibly because the US Federal Reserve is raising interest rates faster than the market is currently expecting, this would probably further strengthen the already solid earnings momentum in Europe.
The profit dynamic is supported by other factors
But there are other reasons to believe that euro area earnings growth will continue its recent improvement. One of them is the booming manufacturing sector, as demand remains resilient while stronger growth in the eurozone can even boost profits for domestically oriented companies.
Another factor is that many European companies are embarking on share buybacks. In doing so, they are following a trend that has been going on in the US for a long time. This should bolster earnings, though perhaps not as much as US stocks.
But above all, Europe is home to strong brands. Premium cars and luxury goods from Germany, Italy and France cannot easily be replaced by cheaper alternatives from other regions. The current global growth environment is another positive factor, as strong international markets can cope with rising prices better than weak ones.
The US imposition of tariffs on steel and aluminum brings an additional element of uncertainty into play. However, it is still unclear how this will work. Regardless of this, we expect global growth to continue. In our opinion, this, together with the improved price environment, robust domestic demand and world-class European brands, can support continued positive earnings momentum in the Eurozone.
Schroders has expressed its own views and opinions in this document. These can change.
This article has first been published on schroders.com.
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