By Isabel Wang
A global economic recovery is fueling a blistering commodities rally in 2024 – threatening to derail the Federal Reserve’s efforts to curb inflation and potentially clouding its path to cutting interest rates by mid-year, according to market strategists.
From oil and gasoline to gold and silver, commodities have started the year on a high note, with some surging to levels not seen in years. The rally has helped stoke renewed inflationary fears among financial-market investors, and spurred worries that the U.S. central bank may have to keep borrowing costs higher for longer than expected.
The Bloomberg Commodity Index XX:BCOM, which tracks 24 of the most-traded commodities futures contracts in the energy, metals and crops sectors, on Wednesday climbed to its highest level since November. The index has been buoyed by energy and gold prices as traders digest escalating geopolitical tensions in the Middle East and the ongoing war between Russia and Ukraine, as well as the possibility that the first Fed’s rate cut won’t occur until at least the summer.
Silver has also gained positive traction, with the iShares Silver Trust SLV on Tuesday posting its best day since May 2023. The advance for precious metals has come despite a stronger U.S. dollar, which on Tuesday rose to its highest level in four-and-a-half months, according to FactSet data.
“What’s going on right now is that the market’s sniffing out the possibility that global growth is going to be better than expected” with more global inflation and higher commodity prices, which makes it a “much more difficult environment” for the Fed to deliver three cuts as expected in 2024, said Nanette Abuhoff Jacobson, global investment strategist at Hartford Funds.
Jacobson pointed to a slew of robust economic data which showed U.S. factory activity grew in March for the first time since September 2022, while an industrial upswing in China has also added to the momentum for a global economic recovery.
“China was a source of tremendous disinflation but its [economic] recovery means that disinflationary external force is also turning around,” she told MarketWatch – adding that these dynamics have cast doubt on whether the Fed will start cutting rates in June.
Against that backdrop, U.S. Treasury yields advanced on Wednesday, with the yield on the 10-year Treasury bond BX:TMUBMUSD10Y rising to 4.37%, its highest level since November, according to FactSet data.
See: Cocoa prices hit another record, sweetening a broad rally for commodities
Oil back in the driver’s seat
Oil and energy stocks are back in the market’s driver’s seat, with oil prices extending their gains on Wednesday as Brent crude futures (BRN00) (BRNM24) rose towards $90 per barrel.
The gains have been buoyed by intensifying geopolitical tensions after a strike by Israel on Iran’s embassy in Syria stoked fears of a widening conflict in the Middle East, while OPEC+ ministers made no changes to current output cuts in a meeting on Wednesday.
However, Stephen Lee, founding principal and portfolio manager at Logan Capital Management, said expectations that strong economic growth in the U.S. and elsewhere could boost oil demand may be the one key factor, rather than geopolitical conflicts, driving oil prices higher. “Oil is now more demand-related than [related to conflicts in] the Middle East,” Lee said via phone on Tuesday.
See: Oil prices extend gains after industry data shows fall in U.S. crude inventories
Energy-sector stocks in the S&P 500 SPX were climbing above their all-time high on Wednesday. The large-cap index’s energy sector XX:SP500.10 is also the best performer among the S&P 500’s 11 segments this week, rising 2.9% while the index overall was off 0.6%, according to FactSet data.
Indeed, the positive correlation between oil prices and energy stocks indicates a “structural shift in oil supply and demand dynamics,” said Nicholas Colas, co-founder of DataTrek Research, in a newsletter dated March 28.
The S&P 500 energy sector does not usually move with oil prices. Since 2001, the 100-trading-day trailing correlation between WTI oil prices (CL00) (CLK24) and the Energy Sector Select SPDR ETF XLE is just 0.55, meaning that prices typically explain just 30% of the daily moves in the energy sector, Colas wrote.
To be sure, energy stocks and oil prices do show “meaningful correlations,” Colas said. “The only time to overweight energy [stocks] is when oil prices are moving higher in a sustainable way. The fact that the large-cap energy [sector] is one of the year’s big winners suggests that the market thinks this is happening right now.”
Precious metals maintain their footing
Despite the potential for further strength in the dollar, precious metals are maintaining their footing on rising physical demand, notwithstanding central banks around the world tightening their monetary policy.
The most-active gold contract (GC00) (GCM24) was on pace for its 12th record settlement of the year Wednesday, while the most-active silver contract (SI00) (SIK24) was on track to end at its highest level in over two years.
Support has come from a few segments where demand for the safe-haven assets has held up particularly well – fueled by growing tensions in the Middle East, uncertainty around the Fed’s pending interest-rate cuts, strong central-bank purchases and the trend in de-dollarization, said Jacobson.
It’s worth noting while the macro backdrop is supportive of gold, the ongoing rate-hiking cycle has still kept many investors on the sidelines, according to Bank of America Global Research.
BofA strategists found that the longstanding positive relationship between gold prices and physical bullion-backed ETFs has broken down, with assets under management at these vehicles declining – a testament to retail investors still having a pile of cash waiting to be put to work, said a team of strategists led by Michael Widmer in a Tuesday client note.
Correlation between dollar and commodities
The advance in gold and oil prices has somehow ignored the persistent strength of the U.S. dollar. The ICE U.S. Dollar Index DXY – which gauges the dollar’s strength against a basket of six rivals, with the euro (EURUSD) receiving the heaviest weight – traded as high as 105.1 on Tuesday morning, its highest level since Nov. 14, according to FactSet data.
Investors want to know if that hints at a shifting relationship between the greenback and commodities.
Traditionally, gold and the buck exhibit a negative correlation, where strength in one usually signals weakness in the other. Yet this relationship has weakened recently, with both assets experiencing a flight-to-safe trade amid global economic and geopolitical uncertainties.
Oil, on the other hand, also has an inverse relationship with the dollar. A barrel of crude oil is priced in dollars across the world – so when the U.S. dollar is strong, the price of oil should be lower in dollar terms, meaning investors need fewer dollars to buy the same amount of oil.
See: Here’s why gold, bitcoin and stocks are all hitting new highs
-Isabel Wang
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04-03-24 1555ET
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