Perspective: Morning Commentary, 01/06/2016

Wednesday, January 6, 2016

January 6 – Stocks fell around the world as economic fears returned overnight, led by a weaker yuan. China lowered its daily fixing for the yuan by 0.22% to its lowest level since April 2011 as it attempts to jump-start its economy. The yuan is at its weakest level since September 2010 in Hong Kong’s freely traded market, down 1% and showing greater weakness than China’s official reference rate, which was down 0.6%. That raises speculation that we will see additional efforts to devalue the yuan in the days and weeks ahead.
China hopes a weaker yuan will increase demand for its products overseas, but it also makes it more expense for the world’s largest importer of raw commodities to import, raising concerns in the commodity sector. The weaker yuan raises the risks that other central banks will put downward pressure on their currencies as well, while also raising the arguments against the U.S. Federal Reserve adding to its recent rate hike.
Demand for treasuries increased overnight as traders sought safe-haven buys, while investor appetite for the so-called riskier assets declined. As a result, stocks and commodities came under pressure as traders worried about a sluggish global economy. The exception was China’s Shanghai Composite Index, which rose 2.25% amid apparent efforts by the government to prop up the struggling market.
A weaker global economy means less demand for energy. As such, Brent crude oil fell below $35 to its lowest level since 2004, while West Texas Intermediate oil dropped more than 3% to sit just above its nearly seven-year low of $33.98 set last month. Weaker crude oil prices are seen as a leading indicator for the broader commodities, which are also under pressure this morning. The fundamental sentiment in the market is that the world will not need to buy commodities if the economy continues to slump, leading fund managers to sell the broader commodity indices. That creates headwinds for the Ags, even though demand for the food-based commodities is somewhat inelastic, meaning people will spend their last dollar on food. Tuesday’s rise in the dollar to one-month highs makes U.S. commodities more expensive overseas.
The Thomson Reuters CRB Index is under pressure this morning, sitting just above last month’s lows that were the lowest since 2002. Commodity prices are already quite low, stimulating periodic investor and end user buying as they try to pick a bottom. Yet, these same traders lack incentive to build ownership, with the global economy continuing to slump amid ample supplies. Fundamentally, we lack a legitimate threat to supply that would encourage a broader rebound in the commodity sector.
Rains have been good for previously dry areas of Brazil’s northern and eastern crop belt, returning lost yield potential in the region while providing some relief to excessively wet areas to the south. The rains are expected to shift back to the south in the last half of this month, allowing early harvest activity to start in northern areas. We likely did see some winterkill damage to wheat in portions of Russia and Ukraine over the holiday break. The scope of those losses won’t be fully known until spring, but local observers currently believe they are within normal ranges for the region, with snowfall returning to the area in the days ahead to protect the crop. Further south, forecast models are suggesting that very dry areas of India’s winter wheat belt may finally see some relief develop across the region over the next several weeks. Periodic short-covering rallies in the Ags can be expected in this environment, but the above factors should continue to make sustained rallies difficult without a legitimate weather threat to the supply. Even so, we should see some position squaring ahead of USDA’s January 12 reports that are known for their surprises.

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