The emergence of Covid-19 pandemic, followed by the subsequent moves by the Federal Reserve cutting interest rates to near zero, created market highs and lows in certain stocks, bonds, and commodities. As the Federal Reserve changed its view on pricing pressure with a higher inflation target and historic monetary stimulus, all capital markets needed to adjust.
We witnessed certain sectors of the equity market and fixed income market act accordingly because of the change in central bank policy. The same can be said for certain commodity groups and sectors.
The Dollar Role
As the world’s reserve currency, the U.S. dollar is the tool by which most important commodity prices are denominated. Theoretically, with all things being equal, a weaker dollar creates higher prices.
Looking at a chart of the last six months of the dollar index against the The Goldman Sachs Commodity Index (GSCI) one can see the inverse relationship between the lower dollar and the higher prices in the underlying GSCI commodities. This relationship between the greenback and the commodity world is the basis for strength across the board in most commodity asset classes.
Outperformers
But within the various commodity sectors there are certain products that have outperformed others as the market recovered.
Looking at a chart of December Wheat compared with December Corn, one can see the relative outperformance of wheat since the pandemic lows in March. While wheat rallied 18% corn could only muster an 11% move higher.
Another good example of outperformance within a commodity group is the move of copper against gold. This relationship is vital for investors because of the signal for growth associated with certain moves. Looking at a chart of the front month copper futures contract against the front month gold futures contract, one can notice the strong outperformance of copper off the March lows taking the metal over 40% higher in 6 months while gold, during the same timeframe rallied 29%.
Economic Signals
When certain related markets start to diverge, it is usually a signal to investors and to the marketplace that an economic shift is taking place. With a possible vaccine for the Covid -19 pandemic closer, market momentum could reflect that change with increased volatility. While a lower U.S. dollar is intuitively inflationary, moves higher in Copper and Wheat vs their related products are historically a sign of strength in the underlying economy.
As the economy searches for normalization, look for certain commodity markets to reflect the growth within sectors. Outperformance within groups is one of the keys to understanding the nature of commodity prices in relation to economic forecasts and predictions especially in the wake of changing central bank policy.
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