The selloff in energy and mining commodities continues on the back of a strong dollar rally which started in mid-April, triggered by a flight out of risky assets and a deceleration of the Chinese economy. This is reflected in the appreciation of the U.S. dollar, when measured by the U.S. Dollar Index (DXY), which is up 4% over the last three months and almost 9% over the last 6 months.
We anticipate the dollar's upward trend will continue as investors trim emerging markets positions on the back of Turkey's lira devaluation, China's slowdown, market-moving U.S.-China trade wars, and Russia/Iran sanctions. We wouldn't be surprised if DXY approaches 100 where it last traded in early 2017.
Copper Catches Turkey Contagion
NYMEX Copper futures are entering bearish territory after sliding below $3 per pound in mid-June, their lowest level since 2017, an 18% fall over the last 6 months, reflecting the negative outlook on global growth measured by China's weaker-than-expected industrial production and retail sales growth, and exacerbated by negative headlines from trade wars and sanctions.
Copper is sensitive to trade tariffs and emerging markets, which are home to major producing hubs. In addition, Union workers in Chile, one of the world's largest copper producers, are preparing a strike against the world's largest copper mine, La Escondida, which is owned by BHP Billiton Ltd. (BHP) .
Energy Being Dragged Along
Central bank intervention to curb currency speculation in emerging market countries such as the Turkey and Indonesia, is causing investors to flee the sector into U.S. dollar-denominated, investment grade assets, exacerbating the selloff in commodities.
Turkey has a 4.6% weighting in the JP Morgan Government Bond Index-Emerging Markets Global Diversified Index, a widely tracked benchmark for emerging market debt and ETF investors, such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) . Turkey comprises less than 5% of the MSCI Emerging Markets Index, a major equities benchmark for emerging markets, with China accounting for 31% of the index.
Macro Traders Adding Noise
Let's remember that base metals account for more than 10% of the S&P GSCI Index, a major commodity benchmark, where copper, represents 4% followed by aluminum. Energy commodities are the largest component (58.6%). Thus, a major drop in a leading commodity like copper could drag along the rest of the components in the basket.West Texas Intermediate (WTI) crude oil is the largest component of the S&P GSCI Index, at 24.7%, followed by Brent crude oil, 16.8%. While geopolitical events such as the Iran sanctions potentially could move the supply/demand balance, energy commodities have traditional moved in the opposite direction from the dollar.
Added to this volatility are a dozen exchange traded funds (ETFs) and exchange traded notes (ETN) tracking commodities. For example, the iShares S&P GSCI Commodity-Indexed Trust (GSC) , which contributes to price dislocation as funds must buy or sell futures to reflect the index weight. The same applies for equity options tracking these indices.
