'Commodities can survive USD strength,' says Wells Fargo
(Kitco News) Can the rally in commodities survive a higher U.S. dollar? Wells Fargo thinks so.
And even though the bank believes in further U.S. dollar weakness, it does examine the possibility that it might be wrong and what that could mean for commodities.
"We believe that commodities still have upside, and the U.S. dollar (USD) still has a downside," Wells Fargo head of real asset strategy John LaForge said this week. "Should we be wrong on the USD, the commodity rally may slow some, but we still think that it survives."
The U.S. dollar index is down 13% since March. But that decline has been a gradual one. During the same time, commodities have been increasing in price. This is a traditional response, with commodities running counter to the U.S. dollar, Wells Fargo said.
"The reason is that many global commodities are priced in USD," explained LaForge. "As the USD weakens, the currencies of other markets often strengthen, which gives these countries extra buying power. This extra buying power can influence commodity demand and commodity prices."
The bank has been projecting a weaker U.S. dollar and higher commodity prices since the beginning of last year. For 2021, it has not changed its mind, keeping the outlook on commodities as "favorable" while expecting a further slide in the greenback. "We are still commodity bullish and USD bearish," LaForge said.
But no outlook is foolproof, which is why Wells Fargo examined whether the commodities rally could survive a stronger U.S. dollar in 2021.
"We believe the answer is yes, commodities can survive USD strength. While the negative connection between commodities and the USD has been strong lately, this historically hasn't always been the case," LaForge pointed out.
In order to gather more information, the bank looked at the commodity/USD correlation since 1968.
"Notice that the line is not always below zero (negative correlation). Commodities are also influenced by other factors (improved Chinese economic growth, low global real interest rates, healing commodity super-cycle), which are generally commodity-positive today," LaForge said.
Even if anticipating a weaker U.S. dollar in 2021 proves to be wrong, the commodities rally will survive but may slow, the bank's report concluded.
In its 2021 outlook, Wells Fargo said that the precious metals were to benefit from low real long-term interest rates, weaker greenback, and loose monetary policies. Industrial metals were set to get a boost from the economic recovery and U.S. stimulus and infrastructure spending. At the same time, energy demand was also expected to come back once the COVID-19 vaccines push the pandemic into a rearview mirror.
Specifically for gold, the bank's outlook maintained that the "fundamental backdrop continues to be attractive" while estimating for prices to end the year around $2,100-$2,200, which would set a new record high for the precious metal.
The bank also advised using gold as part of a "tactical commodities allocation (2% to 4% of the portfolio) in an effort to hedge against risk and provide a level of diversification."