The U.S. dollar’s loss is Canada’s gain
Most investors would agree that February was far kinder to investors in Canada than January. After posting a -4.9% simple price return in January, the TSX Composite Index added 3.3% in February. As at the end of February, the TSX Index is down 1.8% year to date which compares favourably to its U.S. counterparts as the Dow Jones Industrial Average is down 7.5%, the S&P 500 is down 9.4%, and the Nasdaq is down 14.4%. The difference in returns between Canada and the U.S. is explained by the fact that resources make up about 45% of the TSX Index and commodity prices have performed very well during the month of February.
Have the fundamentals of many commodities all improved at the same time to justify seeing so many of them, whether they be energy, metals or agricultural, move higher in price?
In all likelihood the answer is no. Yes, we can attribute some of the increases seen to fundamentals and seasonality, but we’ve also likely seen momentum investors and hedge funds increase the flow of funds into this part of the market. As is the case with any market downturn, investors are constantly on the lookout for winning investments to offset losses. Commodities appear to have been the “winning” area of the market last month. If not completely related to fundamentals, why have most commodities enjoyed such gains? The answer lies in the weakness of the U.S. dollar. Since almost all commodities traded globally are priced in U.S. dollars, if the U.S. dollar weakens then all of the sudden commodities become more expensive for Americans to buy, thus driving up U.S. denominated prices. For example, in the month of February, U.S. natural gas prices have increased 12.4% while oil prices were 11.0% higher in the energy space. Agricultural commodities were higher last month with corn, soybeans and wheat up 9%, 19% and 15%, respectively. On the precious metals front, gold prices added 5.2%, while silver prices finally played catch up to gold adding 17.1%. And in base metals we saw aluminum move higher by 14.8%, copper advance 15.8%, nickel add 15.3% and zinc climb 9.1%. Obviously there is a lot of money chasing these commodities at the same time when we see increases such as these across the board. For that reason we would advise caution when stepping into the commodity space today as investors must pay close attention to valuations. We can make a good argument for the gains made by some commodities such as precious metals as the U.S. dollar has weakened, supply/demand fundamentals remain tight and U.S. inflation remains high. However, it is becoming more difficult in the near term to justify the magnitude of other commodity gains, especially as the picture for U.S. growth remains unclear.
Our overall view of staying defensive in current markets is still in place. Although commodity prices may have provided support for the TSX Index during the month of February, we have seen little, if any improvement to the credit markets which will be a necessary catalyst to turn around equity markets in the long run.