It’s time to pay attention to commodities

The commodities market is on the move. It had one of its biggest gains of the year on Monday. Although the big jump in oil prices and metals goes a long way toward explaining why the Bloomberg Commodities Index has risen to its highest level since early March, the current rally is about much more than just energy.

The 11 per cent surge in the Bloomberg Commodities index since late June is becoming more broad-based, with even some parts of the long-suffering agricultural part of the market starting to see some strength. On the Chicago Mercantile Exchange, December cattle futures are up about 15 per cent since the end of August. Last month, the International Monetary Fund month boosted its 2017 global economic growth forecast to 3.6 per cent from 3.5 per cent. What makes the current rally all the more impressive is that it coincides with a rising dollar. Since commodities are largely priced in dollars, a stronger greenback tends to damp their appeal, but that’s not happening.

The fund is up 20.1 per cent from its low for the year on June 22, topping the S&P 500 Index’s 6.43 per cent gain.

The rally in commodities is likely to reignite the debate about whether the rise in raw materials prices is inflationary or a drag on the economy. A look at the bond market suggests fixed-income traders are coming down on the side that higher commodities prices will act as a headwind on economic growth.

That can be seen in break even rates on US Treasuries, which give a sense of what traders expect the rate of inflation to be in the future. Break even rates have been stuck in a tight range since mid-September. Also, the yield curve has been shrinking, and is now the flattest since 2007. A narrowing curve is usually a predictor of a slower economy. The gap between short- and long-term rates is compressing largely because yields on longer-maturity debt are falling. The opposite would be happening if traders really thought inflation is about to accelerate, because then they would demand more in yield to compensate them for the risk of rising consumer

prices.

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Maybe the rally in global commodities won’t lead to faster inflation, but the equities markets are signalling that the worldwide economy is certainly strong enough to withstand the gains in raw materials prices. The MSCI All-Country World Index of stocks rose for the eighth straight day, its longest rally since July.

The benchmark is up 18.5 per cent for the year, paced by emerging-market stocks, which have gained 31.5 per cent. That makes sense because developing-nation economies largely depend on the production and sale of commodities. In its latest forecasts, the IMF said it expects emerging-market economies to expand 4.6 per cent this year and 4.9 per cent in 2018. The big winners on Monday were the large oil-service providers, which were having their best day this year thanks to a bullish forecast from Morgan Stanley and the announcement of a $3 billion share buy-back from Baker Hughes. The rally comes after investors last month punished the providers of drilling services and equipment for reporting lacklustre third-quarter results.

Where commodities go from here may depend a lot on the dollar. While the greenback was broadly lower on Monday, large speculators such as hedge funds are starting to reverse bets that it will weaken. Since the first week of October, they’ve cut their net short position against the dollar by about 174,232 contracts to 92,788 contracts, according to Commodity Futures Trading Commission data. Dollar pessimism has ebbed as traders have priced in greater odds that the Federal Reserve will raise rates in December, according to Bloomberg News’ Katherine Greifeld.

A big driver of the Bloomberg Dollar Spot Index, which is up almost 4 per cent from its lows in September, has been the higher yields global investors can get on dollar-denominated fixed-income assets relative to other developed markets. The big gain last month in the dollar coincided with that spread topping its high for the year in March.

Corporate earnings season is ending strong. Members of the S&P 500 Index are on track to deliver 6.4 per cent year-over-year growth in earnings per share, according to Bloomberg Intelligence. That’s well above forecasts of a 3.7 per cent increase. Among the more than 400 companies that have reported results, 69 per cent beat EPS projections while 18 per cent missed, according to BI. Technology, health care and energy are notable outperformers, while industrials — namely General Electric — along with financials such as insurance companies, telecom and utilities are on track to miss sector forecasts.

China will be releasing data on its foreign reserves any day now, and the results will likely get more scrutiny than usual given US President Donald Trump is heading to Beijing during his current trip through Asia. The consensus calls for a slight increase to $3.118 trillion in October from $3.109 trillion in September. Bloomberg Economics said China’s reserves, which have steadily climbed this year from just under $3 trillion in January, will benefit from a stable yuan, steady growth, new controls on outbound M&A, and continued opening of the bond market.

Although the increase in reserves largely tracks China’s rising trade surplus with the US, which at $347 billion is a level Trump recently called “embarrassing”, the US does benefit. Treasury Department data show China’s holdings of US government bonds rose $142.1 billion this year to $1.20 trillion through August. China accounted for 54 per cent of the $263.4 billion of bonds bought by all nations.