Slowing global growth is starting to become visible in macroeconomic data – from weaker manufacturing data, in particular in Germany to lower reported gross-domestic-product (GDP) growth across the globe. While these developments are not necessarily new, the recent escalation of the trade conflict between China and the United States highlights how quickly the world economy could lose its balance. Following the announcement of a new round of tariffs, China has suspended the purchase of U.S. agricultural products, a measure that particularly affects farmers in the Midwest of the United States [ CIO Flash as of 8/6/19 ]. To meet domestic demand, China will probably buy soybeans from Brazil and Argentina. However, uncertainty surrounding trade talks and production will likely continue to plague key agricultural products.
As evident from the chart, the entire agricultural sector performed very weakly. The sector got off to a difficult start after a bearish United-States-Department-of-Agriculture (USDA) acreage report, as of the end of June. Positive political signals on trade following the G20 meetings failed to boost markets, even before the recent re-escalation of tensions. Nevertheless, we expect that corn and soybeans will have the potential to outperform. Of course, we acknowledge demand concerns. However, demand risks from trade talks have overshadowed the supply concerns due to bad weather conditions earlier in the year. For now, the impact of reduced planting acreage is still absent from World-Agricultural-Supply-and-Demand-Estimates (WASDE) published by the USDA. Once it starts showing up in the reports, we believe that the attention of market participants – currently very nervous about the rekindling trade war – could rapidly shift from weak demand to even weaker supply. Either way, we would expect to see increased volatility in the market.
Speaking about volatility, oil has exhibited very sharp movements recently. During July, geopolitical crises provided support for the oil price. However, on August 1, it had the largest one-day decline since 2015 after President Trump announced the imposition of 10% of tariffs on another $300 billion worth of Chinese imports. Given this decline, we believe that the oil price currently reflects fair value. We believe that slightly weaker year-over-year demand, coupled with the manifestation of continuing supply-side risks should balance the market in the short term. Toward the end of the year, however, we expect production in North America, Brazil and Norway to pick up, providing a headwind for oil prices. At the same time, we expect oil demand to pick up, partially due to seasonality. We believe, however, that neither increased demand nor OPEC's production cuts will be able to absorb increased supply to keep the market in balance. Consequently, we have switched our strategically positive view on the oil price to neutral with a slightly negative outlook.
Amidst these developments, China's currency devaluation has further shaken things up for a wide range of commodities. It also brought the trade conflict close to a fully-fledged currency war. This is critical as a weaker yuan will make oil more expensive for Chinese consumers, which could, in turn, weaken demand further. The Middle Kingdom's attempt to limit the yuan weakness should, however, dampen such fears. Nonetheless, China will likely attempt to avoid U.S. crude, given ongoing trade tensions.
And while macroeconomic uncertainties have taken a toll on the more cyclical commodities, gold stood out during the past 30 days. Silver did even better, while the gold/silver ratio flirted with all-time highs previously. Despite the recent positive performance however, we remain tactically neutral. The main reason is that while the cut of the federal funds rate by 25 basis points (bps) weakened the U.S. dollar slightly, the U.S. currency is again trading at pre-interest-rate-cut levels. One reason for continuing dollar strength might be the July Federal-Open-Market-Committee (FOMC) meeting comments which were interpreted by the market as hawkish. Such dollar strength looks set to limit the upside of gold in the short term. In the longer term, we believe that a slowdown in global trade is likely to persist and emerging-market (EM) central banks will likely continue to diversify their reserves into gold. High valuations in equities, the metal's relative attractiveness to U.S. Treasuries and a potential global economic slowdown may also make gold a relatively attractive asset class to consider.
As long as macro headwinds persist, we keep our cautious outlook on base metals. Once these clouds move aside, we expect attention to shift to the fundamentals, which already look quite supportive in many instances like copper. For now, however, trade-related volatility looks set to continue to overshadow even relatively healthy fundamentals.
Past 30-day and year-to-date performance of major commodity classes
Sources: Bloomberg Finance L.P., DWS Investment Management Americas Inc. as of 8/9/19
