The raw material markets posted a small gain in the second quarter of 2017, but we saw mixed results across the various sectors. The performance was disappointing as a lower dollar offset higher interest rates. The overall commodity sector consisting of 29 of the primary commodities that trade on U.S. and U.K. exchanges moved 0.92% higher for the second quarter of 2017 that ended on June 30 and is now up 2.97% in 2017 following on the heels of 13.41% appreciation in 2016. The overall winner of the 29 for the quarter was Minneapolis wheat futures, posting a gain of over 43% for the quarter. So far in 2017, it has also been the best performing commodity for the first six months of this year.
The U.S. dollar is a major factor when it comes to commodity prices as it tends to have an inverse value relationship with raw material prices. The dollar index corrected lower by 4.79% over the quarter and is down 6.71% over the first six months after rising to the highest level since 2002 on the first days of 2017. The long-term bull market in the dollar continues to be supported by interest rate differentials with other currencies and the prospects for fiscal stimulus via the biggest infrastructure building project in the United States since the 1950s. However, critical support for the dollar index now stands at the May 2016 lows of 91.88 which is a level that could be a magnet for the dollar over coming weeks as the trend is lower.
The Fed hiked the fed funds rate by another 25 basis points on June 15 and indicated that rates are likely to go up by the same amount once more in 2017. A hawkish statement followed the meeting, and the Fed also announced that they would be reducing their balance sheet by $50 billion per month. At the same time, ECB President Mario Draghi has adopted a hawkish tone, and market perception is that the days of historically low interest rates are coming to an end. The economic slowdown in China had weighed on demand for raw materials around the world in 2015 and early 2016, but the Chinese economy appears to be responding to favorable news from the U.S. and Europe as their latest manufacturing data showed positive signs for China’s economy.
The price of crude oil, perhaps the most closely watched commodity, was stable throughout much of Q2. However, in the wake of an OPEC announcement that the cartel will extend production cuts through Q1 of 2018, the price fell to the lowest level of the year at $42.05 per barrel on the active month NYMEX futures contract. The blockade of Qatar by Saudi Arabia and its allies in the region caused concern that OPEC might fall apart and the production agreement would become void which added to selling. Increased shale production from the U.S. has more than offset the OPEC production cut, and the price of nearby NYMEX crude oil futures has moved below the $50 per barrel level where it was trading for the majority of Q2. Towards the end of the quarter, the price rebounded to close above $46. Supplies continue to weigh on the price of oil as the Energy Information Administration told markets that U.S. production could rise to over 10 million barrels per day in 2018. Gold moved lower during the quarter as higher rates weighed on the yellow metal and it ignored the continued slide in the value of the dollar. A flash crash on Monday, June 26, caused by 1.76 million ounces of selling at the opening of the London market in the COMEX futures market over a one minute period tarnished the yellow metal for the final week of the second quarter.
On the political front, the election in France caused a great deal of uncertainty, but the landslide victory by a pro-EU candidate, Emmanuel Macron, was followed by a rally in the euro currency. Hawkish comments by ECB President Mario Draghi pushed the euro to above the $1.14 level against the dollar by the end of the quarter, which was the highest euro-dollar exchange rate of 2017. In September, Germans will go to the polls, and it appears that Chancellor Angela Merkel will win a fourth term as Chancellor, cementing the future of the European Union after uncertainty last year after the Brexit referendum in the United Kingdom. In Asia, tension continues to build around North Korea’s nuclear missile tests and the potential for a response from the United States. The temperature in the Middle East has increased with the blockade of Qatar and violence in Syria and Iraq. U.S.-Russian relations are at a post-Cold War low over world events, but Russian President Vladimir Putin will meet with U.S. President Donald Trump at the G-20 meeting in early July. Russian influence in the November election in the U.S. has hung over the new U.S. President, and the relationship is complicated because of Russia’s relationship with the Assad regime and Iran. There are so many issues facing the world these days, and uncertainty about the future tends to cause volatility in markets across all asset classes. Meanwhile, U.S. equity markets continued to power higher during Q2 with the DJIA posting a 3.32% gain, the S&P 500 up 2.57%, and the NASDAQ rallying 3.87% in Q2.
Aside from politics and economics, the third quarter brings with it the summer season and the time of the year where farmers in the United States tend their crops that feed the nation and the rest of the world. The U.S. is the world's leading producer and exporter of corn and soybeans and a major exporter of wheat. The weather across growing reasons during the planting, growing, and harvest season will determine the path of least resistance for the prices of grains. After four straight years of cooperative weather conditions and bumper crops, inventories are at record levels, but each year is a new adventure because of the uncertainty of growing conditions which will likely add price volatility to the grain markets over the weeks and months ahead. At the end of Q2, drought conditions in North and South Dakota and a bullish crop progress report caused sharp rallies in the grain markets over the final week of the first half of the year.
Many factors will contribute to the price direction for commodities market over the coming three months. Commodities posted a small gain in Q2 of 2017, but we saw some big winners and losers over the period.
During the period from April 1 through June 30, 2017, the animal protein sector, led by gains in lean hog futures was the best performing sector in the commodities market with a gain of 15.13% for the second quarter. The grain sector came in a close second in the commodities asset class with a composite gain of 13.34%. While agriculture ruled, the soft commodities sector did not participate.
The big winner in Q2 was MGE what which climbed 43.7% over the three months. Lean hogs appreciated by 38%, oats moved 29.32% higher, followed by KCBT wheat and CBOT wheat which were up by 21.58% and 19.81%, respectively. Rice futures gained over 16% during Q2. The only other double-digit gainer was feeder cattle which moved 10.43% to the upside over the three-month period that ended on June 30, 2017.
Other notable gainers during Q2 were palladium, which added to gains from previous quarters rallying another 4.78%, and copper, which was up 1.66% on COMEX and 0.89% on the LME. Corn futures were 1.72% higher, and soybean oil managed to gain 3.62% despite losses in the other two commodities in the oilseed complex. All of the other major commodities came out on the losing side in Q2, which was a quarter that saw lots of price corrections to the downside.
The biggest loser was the soft commodities sector where each of the five commodities posted losses. The composite of sugar, coffee, cocoa, cotton, and frozen concentrated orange juice traded on the Intercontinental Exchange lost 11.52% during the second quarter of the year. The second worst performer was the energy sector where losses in oil, oil products, natural gas, and ethanol added up to a move of 7.61% to the downside for the sector. Precious metals, the best performer in Q1, dropped 2.09% as the weak dollar could not bolster the prices of gold, silver, and platinum over the past three months. Base metals were down 1.75% in Q2 as copper was the only commodity in the sector to post a gain.
The biggest loser during Q1 was the volatile Baltic Dry Index which fell by 30.51% over the three-month period. The price of iron ore shed 21.37% of its value in Q2, and sugar futures lost 17.60% of their value. Gasoline futures moved 11.16% lower, and coffee futures lost 10.95%. Crude oil, cocoa, and silver all lost between 9 and 10% of their value while nickel's loss amounted to just over 6.25%. Heating oil, ethanol, and natural gas all lost around 5%. While platinum, aluminum, cotton, and live cattle all lost between 2% and 5% in Q2. Other small losers of between 0-2% include gold, lead, tin, zinc, soybeans, and soybean meal.
More losers than winners
Commodities are volatile assets. There were more losers than winners in the commodities asset class for the second quarter of 2017. Out of the 29 commodities futures that I include in my simplistic composite index, 22 posted losses for the quarter. The only reason the composite was up by 0.90% was the huge gains in the wheat complex as opposed to much smaller losses in other commodities.
The dollar index fell by almost 5% in Q2, and most commodities moved lower. The historical inverse relationship between the greenback and raw material prices did not work very well over the three-month period that ended on June 30, 2017.
History - Results from my best bets for Q2
The results of my best bets for Q2 from my Q1-2017 report are as follows:
- Commodity prices are likely to follow the dollar and interest rates - This was a loaded statement and I certainly did not realize it at the time. Interest rates moved higher in Q2, but the dollar moved steadily lower. While the commodities composite was up by 0.90% for the quarter, 22 out of 29 raw material markets that trade on the futures exchanges in the U.S. and U.K. moved lower.
- Agricultural commodities, grains, continue to be cheap and offer limited risk opportunity on the long side since the selloff at the end of Q1 - Grains were the second-best performing commodities sector of Q2 posting a gain of 13.34% for the quarter and all markets but soybeans and soybean meal moved higher on a quarter-to-quarter basis.
- The path of least resistance for interest rate sensitive commodities depends on inflation rather than short-term rates - rates can rise and so can raw material prices - I continue to believe that inflationary pressures will build because of almost a decade of cheap capital that has flooded the global economic system via historically low rates and programs of quantitative easing.
I will reiterate what I said at the end of Q1, "market volatility means that we cannot look to hold positions for long periods. These are trading markets that require tight stops for protection. When profits present themselves, take them as there will always be an opportunity for another trade.”
Best bets for Q3 2017 - Commodities
As we move into 2017, there are lots of events that will move markets across all asset classes.
My best bets for Q2 are:
- I believe the weak dollar and flight of digital currencies is bullish for precious metals.
- Agricultural commodities had a great run in Q2, positive crop reports could lead to sharp selloffs while drought conditions could prove explosive.
- Soft commodities have declined to levels where risk-reward favors scale down of long positions.
- Crude oil should eventually drift back towards $50 as political risk in the Middle East continues to mount.
- Stocks remain expensive at current levels, and I expect volatility to increase in Q3 and Q4 with some vicious price corrections.
Many opportunities lie ahead in the commodities markets in Q2 and throughout the rest of 2017. Commodities are volatile assets and trading rather than investing is likely to yield optimal results. Keep your stops tight and take profits when they are on the table. Never worry about missing a trade or investment because there is always another opportunity just around the corner.
Specific details of my 13 best bets for Q3 are available to subscribers to my newsletter.
Each Wednesday I provide subscribers with a detailed report on the major commodity sectors covering over 30 individual commodity markets, most of which trade on U.S. futures markets. The report will give an up, down or neutral call on these markets for the coming week and will outline the technical and fundamental state of each market. At times, I will make recommendations for risk positions in the ETF and ETN markets as well as in commodity equities and related options. You can sign up for The Hecht Commodity Report on the Seeking Alpha Marketplace page.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.