15 indexes and CFDIs

Commodities appear to be at a discount in a nascent bull-market trend. The normalization process in stock-market volatility and strengthening dollar have suppressed commodity prices, but favorable fundamental and technical conditions should prevail. Broad-market demand vs. supply indicators remain positive as energy and agriculture are near potential floors. WTI crude oil is ending the month near $65 a barrel and good support vs. $75 and multiyear highs in September.

If the Brazilian real has bottomed, it should be a game changer for soft commodities and mark a potential bottom for agriculture. Metals are ripe for recovery once the dollar arrests its rally. Midterm elections should play a role. The greenback appears to be pushing on a string vs. U.S. stock outperformance.

October may mark a game changer for firming commodity foundation
With crude oil near good support and the Brazilian real potentially at a bottom, the Bloomberg Commodity Index is forming a bit of a floor. Underlying broad-commodity demand and supply conditions remain favorable, which should prevail with higher prices once the dollar stops advancing.

Commodities appear at discount in bull market
The primary demand vs. supply indicators for commodities remain squarely in positive territory. Consistent with favorable trends in futures curves (toward backwardation), the Bloomberg Commodity Spot Index appears to be on sound footings, particularly due to the discount from the May peak. That apex (near the halfway mark of the 2011-16 bear market; about 10% higher) was into good resistance. Commodities appear to be in early recovery days along with most inflation measures. Mean-reversion risks from multidecade lows favor rebounding commodities.

The biggest risks are likely sustained dollar strength or a sharp stock-market decline. These factors could pressure the BCOM to revisit the upward-trending 36-month moving average, about a 6% decline.

Greenback pushing on a string vs. commodities
Continued fuel from a strong dollar is likely necessary to keep commodities down. A decline of about 1.5% in the Bloomberg Commodity Spot Index was about the reciprocal of an advance in the trade-weighted broad-dollar index. Their relationship over the past few years shows divergent strength. Despite the greenback advancing about 4% on a two-year basis, commodities are up about double that amount.

The S&P 500 giving back 2018 gains was October’s primary macro-performance story, though emerging-market stocks are more directly correlated to commodities. With declines approaching 20% in 2018, the MSCI Emerging Markets Index has had a significant drawdown that appears less likely to accelerate. Simple mean reversion in EM stocks and the dollar would be commodity-positive.

Real recovery in softs; Crude oil back to support
Crude oil backing away from the four-year high at the end of September is our primary bearish commodity takeaway from October. Declining toward good support at month’s end should be a positive for November. WTI crude oil was overdue for a correction, but the downside is limited near initial support at $65 a barrel. The strong dollar also pressured commodities, but not vs. Brazil. The recovering real in the aftermath of the election may mark a game-changing bottom for soft commodities and agriculture. If the real has bottomed, the ags might have as well.

Industrial metals down about 16% on the year and the leading loser is a bit disconcerting for global macroeconomic implications. That’s part of the reason recovery is more likely. Continued base-metals weakness has more bearish implications for equities.

Attribution analysis indicates likely recovery
Crude oil ending the month near good support, plus the potential for a bottom in the Brazilian real, provides a floor on returns for about half of the broad index. Energy, the primary supportive sector in 2018, is unlikely to give back much more of the 370-bp total index contribution. WTI crude oil ends October near good support at $65 a barrel. Agriculture’s drag of about 300 bps on the index should lessen if Brazil’s currency has indeed bottomed.

The metals will likely need further dollar appreciation to continue to subtract from index total returns. Base metals have been a drag of about 300 bps this year on the back of about 160 bps from precious.