Will Commodities Offer Protection From Inflation?

A range of asset prices demonstrates that investors are factoring in a shift towards a new inflationary environment. It’s the big theme running through the markets, and the question is how do investors position themselves for the change in mood? It appears to be a case of when, rather than if, and commodities may be part of the answer.

Move to an Inflationary Environment Has Started

The US dollar basket index, which matches the greenback against the world’s largest free-floating currencies, is pushing on with a multi-month double-bottom breakout. The DXY Basket index chart shows there’s even a claim for the move being based on a triple-bottom pattern – if you factor in the low of 87.86 in February 2018.

Source: IG

On Monday, the usually low volatility USDJPY currency pair posted an out of character +1% swing in value in favour of the dollar

Source: IG

Growth stocks in the Nasdaq continue to shed support and value as the threat of higher interest rates leads many investors to take a different view of their sky-high valuations. Market titan, Apple Inc, was down 1.2% in after-hours trading on Tuesday. Reports of a chip shortage impacting production capacity were credited as the catalyst. However, there are a lot of slow-burn factors, most of them relating to inflation, which could also be credited with causing the move.

Source: IG

Two traditional methods of riding out inflation and a high-interest rate environment are banks and commodities. The banking sector traditionally outperforms when base rates are higher because the bid-offer spread and margins on their products get squeezed when interest rates are near zero. If they offer unfavourable interest rates to savers, account holders are as likely to stuff cash under their mattress as hold it at a bank.

Financial firms could be months or years from feeling the benefits of the change in the underlying macro trend. Rate hikes are on the cards but might not gain traction until next year and will only move incrementally. The market which looks more likely to respond sooner rather than later is commodities.

Holding physical assets, or shares in the firms that dig them out of the ground, such as listed iron ore and copper miners like BHP, is one way to hedge against price rises. Like most other stocks, the mining sector firms rebounded from the March 2020 lows, but they’ve since posted a significant pullback that will interest dip-buyers.

Source: IG

BHP’s year to date high of £25.04 on the 16^th of August and the subsequent pullback to the 38.20% Fib retracement level will be catching the eye of those adopting momentum trading strategies. The Fib level offers support, and buyers can take comfort from the stock continuing to print those much-loved higher highs and higher lows.

Source: IG

There is resistance in the region of £20.00. That could be down to it being a ‘big number’, but as the stock is dual listed, there is a need to consider other factors as well. But £20.00 appears an appropriate first price target, and a stop below the previous swing-low of £14.50 of October 2020 offers a cap on downside risk.

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About the author: Justin Freeman

Justin is an active trader with more than 20-years’ industry experience of working for big banks and hedge funds. He has an inside knowledge of how the financial markets work, thanks to roles including trader on a $750m Event-Arbitrage desk and CRO and COO of hedge funds running a variety of strategies. From stat-arb and trend-following CTA to fixed-income relative value. Firm’s he has worked at include big banks like Citi, and prominent hedge funds including D. E. Shaw and Millennium Capital Management.

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