Most commodities ended 2020 on a positive note, benefitting from huge monetary inflows by central banks, robust demand from China, favourable weather, a weaker dollar and the progress on COVID-19 vaccine.
Building on the momentum, commodities extended the gains in the first week of 2021 ,backed by persisting weakness in the US dollar.
Stimulus expectations and a weaker dollar helped gold price test the highest level since November 2020. Industrial metals also maintained their upward momentum with copper testing 2013 highs. Crude oil also surged to February 2020 highs as general firmness in commodities was coupled with Saudi Arabia's surprise production cut announcement. Agricultural commodities maintained their bull run with soybean hovering near 2014 highs.
The dollar index slumped to April 2018 lows during the week on hopes of continuing stimulus measures. Democrats won both the seats in the run-off election in Georgia, giving them a majority in the Senate. Democrats will now have a majority in both the House and Senate, which will make policy reforms easy.
One of the long-standing demands of Democrats is a bigger stimulus to support the economy and with a majority in Congress, a decision may become easier.
Adding to stimulus expectations, FOMC minutes highlighted that the central bank wants to keep interest rates low until there is substantial recovery. The Fed also wants to avoid a taper tantrum and will give clear signals as to when it intends to scale back bond purchases.
Mixed US economic data also made a case for continuing stimulus measures. US ADP jobs report noted an unexpected decline in private-sector jobs in December, highlighting the pressure on the labour sector.
The surge in market expectations of a bigger stimulus, however, improved the outlook for the US economy and boosted inflation expectations, pushing US 10-year bond yield above 1 percent for the first time since March 2020. The rise in yield helped the dollar index recover from lows and put an unsteady halt to commodities.
The dollar index has been on a downslide and with stimulus expectations and worsening virus situation in the US, the general outlook remains weak. However, the possibility of a short-term pullback can't be ruled out.
There are also other challenges for commodities in the form of rising virus cases as more cases of the new variant of coronavirus are being reported worldwide and countries are imposing stricter restrictions to limit the spread.
Another challenge is in the form of rising US-China tensions. It will be almost a year since the US-China partial trade deal was signed but no major progress has been made on trade issues since then, while tensions have intensified. Also, market players will focus on other policy implications of a Democrat win in the US. Apart from a bigger stimulus, the Biden administration is also expected to work on tax hikes, cleaner energy etc.
(Ravindra Rao is the VP - Head Commodity Research at Kotak Securities.)
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