US dollar headwinds

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FAT PROPHETS: The US dollar hit an 8-month high on Monday on expectations of a Fed rate hike in December, which put metals and commodity prices under more pressure, whilst stock markets generally held. Some analysts are concerned that a supply response will not be forthcoming from producers as the US$ strengthens, with volumes being maintained to compensate for lower prices. However, with the commodity price index under pressure, I think it is only a matter of time before supply begins to contract as higher cost producers go out of business.

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New highs are imminent for the US dollar index as the bull market gathers upward momentum after a breakout from a multi-month consolidation during the year. However, I think the strong US dollar will prove to be ‘heavily influential’ at next month’s Fed meeting and this could see the market’s expectations in terms of the quantum of probable rate hikes next year, disappointed. For now, and running into the meeting over the next few weeks, the US dollar is headed higher.

In the iron ore industry, key producers such as Fortescue Metals are going to come under significant pressure if prices go below US$40 a tonne, as industry economist and iron ore bear Andy Xie is predicting. Mr Xie believes prices could trade in the US$30s by 2016 as demand in China declines.

He went on to say on Bloomberg that “mills in China will cut output and high-cost iron ore miners will go under…The steel industry is reaching a critical point. They’ll have to cut production”.

The largest producers, BHP, Rio and Vale will maintain production and this will almost certainly see their market share expand, but the overall market will shrink with the departure of smaller players with loss making operations. We have seen this dynamic in iron play out in a host of other commodity industries such as oil, and also now copper.

We have maintained a significant underweight exposure to commodities in our portfolios and I continue to believe this is the correct strategy until we see definitive turning points in the prices of commodities within the resources sector. Significant value has emerged within the resources sector but there is also an opportunity cost of being early on the buy side. Whilst stocks like BHP may not get much cheaper in the months ahead, it could prove to be a long wait before the cycle turns around.

Other commodities have come under significant pressure as a result of US$ strength. Copper fell to its cheapest level in six months before recovering on Monday, while in London nickel slid to its lowest since 2003. Gold fell nearly one percent towards last week’s near-six-year low, but in relative terms has held up the best within the sector.

Crude oil prices rose after Saudi Arabia’s pledge to work on price stability offset some worries about the global oil glut. Benchmark Brent futures were up 41 cents at $45.07 a barrel. US crude’s West Texas Intermediate futures rose 7 cents to $41.97 a barrel. OPEC is meeting in Vienna in December with the cartel likely to put pressure on Saudi Arabia to curb its output.  Countries like Venezuela are seeing an economic slump on the back of low oil prices.

The boom in mergers & acquisitions and corporate activity continued in earnest yesterday with Botox maker Allergan and Pfizer (recommended by our US equities team, and one of the world’s largest drug manufacturers) announcing a record deal worth $160 billion to create the world’s biggest pharmaceutical company.

The deal has already created controversy. The combined company would have a base in the US, but be headquartered in Ireland (where Allergen is currently based) and this would see the overall amount of tax paid significantly reduced. Ireland is considered a tax haven for many companies.

The Eurozone economic recovery is continuing with a preliminary composite PMI reading for November coming in at 54.4, the highest level in almost 5 years and sharply up on October. The composite PMI signals expansion when it is over 50 and combines both manufacturing and services. The Eurozone manufacturing PMI came in at a 19-month high of 52.8 versus 52.3 in October, whilst the flash manufacturing output PMI index hit a 3-month high at 53.9. The overall picture is signalling the strongest business activity in the Eurozone in four and-a-half-years.

In the US, housing and manufacturing data were both weak with existing home sales falling by 3.4% to a rate of 5.36m in October following a 4.7% jump in sales in September.  The drop was larger than the 2.7% decline that had been forecast. The flash US manufacturing PMI for November was also weak with it coming in at a 25-month low at 52.6.  This compares to 54.1 in October and is a key indication that the strength of the dollar is going to become a powerful headwind for the US economy and especially manufacturing.

I believe this will deter the Fed from raising rates quickly and the trajectory of monetary policy will likely be very different than during the last cycle in the prior decade. 

For nearly 15 years, Fat Prophets remains UK’s premier equity research and funds management company. Register today to receive our special report Bargain Hunting, and a no obligation free trial to our popular email service

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