Granada in Favoured Position as Metals from copper to gold set to shine in 2019 with peak dollar: Says Bloomberg Intelligence

This analysis is by Bloomberg Intelligence analyst Mike McGlone. It appeared first on the Bloomberg Terminal. 

Access the full Bloomberg Commodity Outlook – January 2019 edition

Metals are at a discount in a bull market that’s ripe for recovery in 2019, with trade tension and a strong dollar — the primary 2018 pressures — near a peak and losing their punch, in our view. A global economic slowdown and sustained appreciation above the highest year-end level ever in the trade-weighted broad dollar are the key threats, albeit unlikely. Copper’s 23% peak-to-trough drawdown in 2018 already prices in a certain degree of risk. It’s more likely to retrace that correction.

Spot gold’s 2018 decline of about 5% to Dec. 19, despite a 9% gain in the dollar, indicates divergent strength. Bullish dollar drivers — a strong U.S. stock market and Federal Reserve tightening — are near an apex, which would support long-dormant gold.

Metals from copper to gold set to shine in 2019 with peak dollar
With exhaustion setting in for the dollar bull market, the metals are ready to take the baton, as we see it. Led by copper, and pressured by the greenback and trade tension despite favorable demand vs. supply trends, industrial metals are ripe to recover in 2019. Priced at a discount, all metals (notably gold) should shine, unless dollar strength persists.

Dollar bull near exhaustion supports metals
Elevated mean-reversion risk for the dollar increases the prospect of metal-price gains, in our view. The trade-weighted broad dollar achieving the highest end-of-year level is indicative of a primary metals headwind that’s near exhaustion. Key bullish drivers for the dollar — U.S. stock outperformance vs. global equities, and Federal Reserve tightening — also show signs of fatigue. The metals’ demand vs. supply signals remain favorable with U.S.-China trade tension, which should thaw in 2019.

The past 20-year correlation of the Bloomberg All Metals Total Return Index to the dollar is negative 0.70 when measured annually, which exceeds the 0.64 positive correlation to spot gold.

Gold’s persistent bullish ‘P’ formation likely to extend higher
The three-year market picture for gold indicates prices migrating higher within an increasingly compressed range, which typically portends a breakout. The primary macro commodity and quasi-currency has sustained support despite a strong U.S. stock market and dollar. It may have accelerated upside potential with mean reversion in these conditions.

Gold ready to follow the lead of natural gas
Much like natural gas earlier this year, gold has the drivers in place to rally from its compressed range. Increasing inflation and debt levels are positive companions, as is gold’s divergent strength to the dollar, which is vulnerable as it nears a good resistance level. Since the start of the current Federal Reserve tightening cycle, and despite rallies in the metal’s traditional adversaries — the greenback (up 5% on a trade-weighted basis) and the stock market (S&P 500 up 36%), the dollar price of gold is up 14%.

With rate hikes nearing a potential end-game, gold is ripe to rally. The narrowest 24-month Bollinger bands for the longest period in 16 years indicate the metal’s upside. For gold to decline, it would likely need the dollar to remain above multiyear highs, plus a decline in equity-market volatility.

Gold is low vs. stocks if dollar has peaked
Gold should shine vs. stocks, particularly if the dollar stops advancing. Our graphic illustrates that the gold-to-stocks ratio is potentially bottoming from a good support level despite a resilient greenback. A declining U.S. equity market is a primary force to pressure the dollar, supporting metals. Mean-reversion risks in the trade-weighted broad dollar near the 2002 and 2016 highs may outweigh further appreciation potential.

Reversion in stock prices and Bitcoin toward their means is more than a coincidence, in our view. They’ve rallied together in the past few years with a common support factor — global quantitative easing. Cryptocurrencies, considered alternatives to fiat currencies such as the dollar, gained plenty of advocates as global central banks rapidly increased money supply to offset deflationary forces.

Copper’s market picture favors the upside
Copper is forming a bullish P-type price distribution. The metal appears to be in the early days of recovering from the lower end of the breakout rally from 2016 and is likely to continue rotating higher, in our view. It will likely take some unlikely forces, such as a significant global slowdown led by China or a sharp rally in the dollar, to pressure copper below the 2018 lows. Nearing the 2002 peak, the trade-weighed broad dollar has limited upside vs. significant potential mean-reversion risk.

The past three-year price concentration area for CME copper centers around $2.65 a pound ($5,880 a ton LME). This is a good support zone and a likely level to build a base for recovery. About $2.90 ($6,500) is initial target resistance. This is the breakdown zone from July and near the 200-day moving average.

Metals demand vs. supply indicate price discount
Industrial metals are discounted relative to favorable demand vs. supply. Our analysis of World Bureau of Metal Statistics demand vs. supply datasets for copper, aluminum, nickel and zinc show the ratio improving above par and for the longest period in the database since 1995. The Bloomberg Industrial Metals Spot Subindex’s discount appears unusual. Pricing for what appears to be a worst-case scenario tips the probability in favor of a recovery once the worst fears of a China slowdown and U.S.-trade tensions are alleviated.

The subindex indicates what some analysts might describe as an oversold condition. The gauge gapped down in July at a similar level as in 2013. That gap marked the peak in 2014 as metals recovered, then succumbed to plunging crude oil.