Commodity Bubble Forming
The timing, as ever, is a little tricky, but at some point during the second half of the year, commodity markets are going to turn lower, and when they do, the move is going to be hard and fast. At the moment, though, the bubble is still forming.
Our view of the world starts with our ongoing bearishness towards equity markets, and financials in particular. Sure, Mr Trichet’s implication that euro rates will not be rising any higher has given good support to global indices for now. But could he have said anything different? Any admission that the refi rate needs to go even higher would have sent the DAX tumbling. Yet, once this short-term bounce has played out, and another US or UK financial institution has gone to the wall, the dollar will come under renewed pressure against the euro. This will see commodity prices trade even higher.
However, the continuation of aggressive monetary policy tightening across emerging markets (EM), to combat in some cases rampant inflationary pressures, coupled with an ongoing reduction in fuel subsidies, at a time of US economic weakness, will lead to a cooling of global growth.
If this coincides with a bottoming of the dollar versus the euro, which we think likely, demand for oil could fall sufficiently to see prices turn sharply lower. We would not be surprised to see front Brent fall pretty quicky to the US$85.00/bbl-90.00/bbl area. This is still a high price of oil, of course, but the move would cause some pain to current long positions, that would no doubt reassess as prices dropped, exacerbating the move lower.
The hard part is determining from what level oil drops. Do we or do we not see one more spike higher? In this respect, if EUR/US$ drop below 1.5300 over coming days, a level we view as key support, the commodity turnaround would be in place. In the meantime, the rally still has legs before a bursting of the bubble later in H2.