The Key Theme of 2018

The most important theme right now – indeed, for 2018 – is that precious and base metals are moving up together. They are doing so along with other commodities (oil, agriculturals) and the moves are all grounded by bullish fundamentals and valuations. And all of that bodes well for the next 50 weeks.

The gains aren’t going to continue non-stop all year, but the fact that metals – commodities as a whole – are gaining together matters for several reasons.

First, multi-metal rallies always create stronger equity gains than single-metal markets. This is something I’ve been saying regularly for over a year now. A gold rally attracts gold speculators; a copper move brings growth-oriented investors; but a multi-metal market becomes a story of its own wherein momentum feeds more momentum, creating greater gains.

Second, the timing is right within the greater economy for metals to make a move. The multi-year stock bull market is based in slow but steady economic growth. That growth has been so slow at times that it seemed non-existent, but patience is starting to pay. Several of the world’s major economies are now looking quite good, from the US to Europe, Canada to Japan. Chinese growth will still slow, but that economy is now SO large that growth of ‘just’ 6% is still incredibly significant, especially in generating new commodity demand.

That demand is already showing up across commodity classes. The first chart below shows the S&P GSCI Index, which is an oil-heavy commodity index that has already broken out above a two-year bottom. The second is the Bloomberg Commodities Index, which downplays oil in exchange for greater weighting to precious metals and agricultural commodities. It hasn’t broken out yet, but it’s darn close.

Zinc is certainly helping these charts. Zinc kissed US$1.55 per lb. earlier this week, its highest level in more than a decade.

The next force working for commodities is currencies. The US is no longer the only economy in the world that’s working, which means the US dollar now has competition. Add in a president who loves a weaker dollar and the possibility of increasingly protectionist policies and there are good reasons to believe the greenback could well stay contained in 2018.

A stagnant US dollar. Increasing demand for commodities, driven by growth. Supply constraints. All bode well for metal prices – and that’s before adding inflation into the mix.

Inflation is fuel in a commodities rally fire. I’m not yet convinced we are going to see a lot of inflation this year, but I am starting to believe that 2018 is the year inflation will at least show up at the party.

Inflation is simply part of growth. Low unemployment means folks generally have jobs and therefore money to spend; it also means businesses start raising salaries in order to retain good employees. Higher salaries for the same job – that’s the foundation of inflation right there. And inflation means higher commodity prices, at least in the currency that’s inflating.

We haven’t seen wage inflation yet. It is one of the canaries (in the gold mine?) that I am watching very closely in 2018. There are endless arguments about how to calculate overall inflation and whether it is already present, but watching wage inflation is one way to sort of sidestep that whole debate.

Once wages start rising, inflation is at hand – and that will mean higher prices for all metals, from copper to gold, as well as greater stock market volatility, likely stemming from US stocks and bonds underperforming those in Europe and Japan, where inflation is not a risk.

Oil is another US inflation argument. Oil’s collapse from US$60 a barrel to $30 barrel in 2015 is old news; the chart today looks strong, backed by generally bullish fundamentals and geopolitics. January brought the price of WTI back above $60 a barrel for the first time in almost two years and many are predicting $70 a barrel this year; some are even suggesting $80.

A recent study by the International Monetary Fund determined that a 10% increase in the price of oil boosts domestic inflation by 0.4%. So a rising oil price only adds to the inflation argument.

That’s a host of reasons for commodities to perform in 2018. Then there are simple valuations.

Last week I published that chart showing how commodity prices are at all-time lows relative to stock prices. Ebullience is high and the bull market in stocks is not going to end tomorrow…but it’s high enough and has gone on long enough that money is looking to diversify.

Commodities are an obvious option: they reliably perform late in economic cycles, they benefit from inflation, they thrive on growth, and they are incredibly undervalued. If 2018 is going to have a theme, it will be money rotating into commodities for diversification and profit.

I’m seeing more and more evidence of this. From Bloomberg headlines aboutmanufacturing booms sending commodity prices soaring to noted fund manager Jeff Gundlach of DoubleLine Capital telling clients “commodities will outperform in 2018… Commodities always rally sharply – much more sharply than they have so far – late in the business cycle…” to Goldman Sachs advising clients to overweight commodities this year for their greater returns over other asset classes – the broad market is starting to rotate our way.

And – this is important – the mining sector is tiny compared to the broad market, so only a little bit of diversification from the bull market into metals would be very significant, generating a big boost for metals, miners, and explorers.

And that will feed momentum, which is a self-fulfilling prophecy. The fact that a select few exploration stocks went absolutely nuts last year (Novo, Garibaldi, GT Gold, and New Nadina, to name a few) shows that there was already some money chasing the commodities opportunity in 2017. And some of that money did very well. In general, if fundamentals – metal prices – are strengthening, money invested in mining should do reasonably well, which creates new capital available to invest in other commodity stocks and simply encourages more money to rotate into the sector.