“All poker is a form of social Darwinism: the fit survive, the weak go broke.” A. Alvarez, “The Biggest Game in Town”

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OVERVIEW AND CONCLUSION

The Bank for International Settlements provides broad real effective exchange rates (“EER”) for numerous currencies around the globe. Within the BIS statistics are several nations who are important exporters of widely-traded commodities such as petroleum, base and precious metals, and agricultural products such as soybeans. Concentrating on and comparing the broad real effective exchange rates of eight freely-traded currencies widely labeled as “commodity currencies” offers insight into assorted interrelated financial marketplace relationships. The overall patterns of this array of assorted export-related commodity currencies often has intertwined in various ways with very significant trends in broad commodity indices such as the S&P Goldman Sachs Commodity Index (“GSCI”) and the Bloomberg Commodity Index (“BCI”), the broad real trade-weighted United States dollar (“TWD”), emerging marketplace stocks in general (as well as the S+P 500), and key interest rate benchmarks such as the 10 year US Treasury note.

In assessing and interpreting the role of and implications indicated by the commodity currency platoon in financial battlefields, marketplace guides should highlight several preliminary considerations. The various commodity currencies (“CC”) do not all move at precisely the same time or travel the same percentage distance in a given direction. Although they generally move roughly together within an overall major trend for the group, an individual member may venture in a different direction for quite some time. Although the path in recent months of the various CCs “together” generally has been sideways, their individual movements have not been identical.

Of course the various commodity currency countries are not all alike. So a given guru can tell somewhat different stories about each of them and their currency. Not all CC nations are equally important within the international trade arena. The various domains do not rely to the same extent on commodities within their export packages. And not all are reliant on a given commodity sector (such as petroleum) as part of their commodity output. Some CC nations produce notable amounts of manufactured goods. In addition, some countries probably are more vulnerable to currency and trade wars than others.

Moreover, the intertwined relationships between currencies (whether the CC EERs or others such as the broad real trade-weighted United States dollar), commodities “in general”, stock marketplaces (advanced nation signposts such as the S+P 500; the emerging marketplace field in general), and interest rates can and do change. Relationships between CC EERs and the broad real trade-weighted dollar (“TWD”) can shift. The TWD’s intertwining and relationship to interest rate, equity, and commodities in general is complex. In addition, although subjective perspectives identify apparent convergence and divergence (lead/lag) relationships between financial territories, these connections (links, associations) can alter, sometimes substantially. Marketplace history is not marketplace destiny, whether entirely or even partly.

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Commodities “in general” surpassed their first quarter 2017 peaks in first quarter 2018 (and April 2018), rapidly climbing from a notable mid-year 2017 trough. The majority of commodity currencies established an EER top in (or around) 1Q17. In contrast to commodities in general, the effective exchange rates of the various commodity currency club members either have not exceeded that top established in (around) 1Q17, or have not done so by much. In addition, the CC group’s EERs generally did not climb much, if at all, from around mid-year 2017. This CC EER pattern (some divergence from commodities in general) warns that a significant top in commodities  probably is near. In the past, highs for the commodity currency EERs linked to highs for commodities in general.

Relevant to this marketplace viewpoint regarding the commodity currency EERs and commodities “in general” is the upward trend in US Treasury note yields. Recall not only the major bottom in the UST 10 year note around 1.32 percent on 7/6/16, but especially underline for the CC (and global stock marketplaces) the yield climb from its 9/8/17 interim trough at just over two percent. The Federal Reserve Board has been raising the Federal Funds rate and gradually reducing the size of its bloated balance sheet. The UST 10 year note broke out in first quarter 2018 above critical resistance at 2.65pc; the UST 10 year  recently bordered 1/2/14’s 3.05pc barrier (3.03pc on 4/25/18; the two year UST note also has climbed, reaching 2.50pc on 4/25/18). Also supporting this outlook for commodities is the 1Q18 peak in the S+P 500 (1/26/18 at 2873) and the MSCI Emerging Stock Markets Index (from Morgan Stanley; “MXEF”; 1/29/18 at 1279).

Yield repression (very low and even negative interest rates) promotes eager hunts for yields (return) elsewhere. These include buying commodities as an “asset class”. What happens to commodities when key central banks begin to end their beloved yield repression schemes, or hint that they will do so?

Marketplace history indeed shows that sometimes there has been divergence between commodities “in general” and stock benchmarks such as the S+P 500 for a while. Recall the 2007-09 global economic disaster era. The S+P 500 peaked 10/11/07 at 1576 (MXEF summit 11/1/07 at 1345), prior to the broad GSCI’s pinnacle in July 2008 (7/3/08 at 894). Yet recall that the July 2008 GSCI peak occurred close in time to the noteworthy S+P 500 interim high on 5/19/08 at 1440, as well as the lower S+P 500 tops of 8/11/08 (1313) and 9/19/08 (1265). And note the timing linkage between the broad GSCI and S+P 500 in the past couple of years. Not only did they make major lows around the same time in first quarter 2016 (broad GSCI at 268 on 1/20/16; S+P 500 on 1/20/16 at 1812 and 2/11/16 at 1810). They both accelerated upward in their bull moves around the same time in mid-year 2017; the GSCI low was 351 on 6/21/17, with that in the S+P 500 6/29/17’s 2406 (8/21/17 at 2417). The broad GSCI slumped from its initial high at 466 on 1/25/18, which linked to the S+P 500’s high on 1/26/18; although the GSCI since has hopped over its 1Q18 interim top, it thus far has not done so by much (480 on 4/19/18).

Thus the failure of the EERs for the CC group as a whole to advance much over the past year and especially since mid-year 2017 (with no decisive overall new highs for the group in general in 1Q18) probably has implications for both commodity and equity trends.

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Commodity Currencies in Context- a Financial Warning Sign (5-1-18)