Tuesday, December 29, 2015

Review of the Currency and Commodity Markets in 2015 and the Outlook for 2016

These 2 weeks are generally the quietest weeks in the trading calendar as big fund managers are taking leaves to enjoy their much needed holiday. I would expect the market to resume its volatility on Jan 4, 2016. Meanwhile, let us take this time to review the past and anticipate the future.

2015 has been a big year for the dollar, as EURUSD drops to 12 year low and USDJPY climbs to 12 years high due to monetary policy divergence. I believe the 1st quarter of 2016 should still be good for the dollar as monetary policy gap expands. While 25bp rate hike is very nominal for the U.S., keep in mind that the Fed has hinted 4 possible rate hikes in 2016. Unless the Fed backtracks on their hawkish view, I would still look to long dollar. But the dollar bulls have to be careful moving towards 2nd half of 2016, as we need to watch out for any detrimental effect brought by the rate hike. A strong dollar has a spillover effect not only to the US, but to the world. A strong dollar will induce more imports and less exports for the U.S., cause lower inflation, lower commodity prices, diminishing corporate earnings for U.S. companies with substantial foreign revenue, less pressure for other major central banks to ease, more pressure for emerging countries with huge dollar denominated debt, and induce more M&A for U.S. companies with higher purchasing power. Also bear in mind that 2016 is the presidential election year for the U.S. Watch out for political risk too.

Canadian dollar, on the other hand, suffers the worst loss in 2015, compared to other major currencies. The loonie lost over 15% of its value versus the U.S. dollar, Japanese Yen and British pound, mainly due to the low oil price. BoC may do a rate cut again in 1st half of 2016, if their recession continues. With many analysts forecasting the oil price to reach as low as $20/bbl because of slowing demand and persistent good supply from OPEC, I would expect USD/CAD to break 1.40 and head towards 1.45 in the first half of 2016.

The EUR for this year has been weak. 6 years after the financial crisis, ECB still fails to turn around the economy, but resorts to unleashing more unconventional stimulus tools such as QE and negative interest rate to stimulate the economy. 2016 will still be bad for EUR as they will still be engulfed by a lot of issues - refugee crisis, sovereign debt crisis, slow growth, low inflation despite considerable amount of QE, ISIS aggression, Russian tensions, systemic weaknesses of EMU, etc. Greece might return to headlines if the government fails to enforce reformation to repay their debt. Italy, Spain and Portugal might be the next countries that may head towards bankruptcy if their debts are not managed well. I would still look to short EURUSD, with two important levels to watch out for - 12-yr low of 1.0459 and parity.

As for sterling pound, the UK economy has done pretty well for 2015, with annualized growth at 2.1% mainly due to good growth in service sector and healthy employment. However its currency behavior was a bit surprising towards the end of the year. With speculation that BoE will be the next central bank to raise interest rate, GBP should head upwards, but instead it was traded downwards. The greatest risk for GBP in 2016 are low inflation and Brexit. The inflation remains way off target for BoE. What makes matter worse is the persistently low commodity prices. The Brexit vote will be an important political event not only for UK but for the entire European Union. BoE might not hurry to raise interest rate during the turbulent time ahead. So my guess is GBP might be traded sideways for most of 2016.

Commodities, be it precious metals, agriculture and energy, should bottom out in 2016. With a strong dollar, weak global demand, and huge supply, oil might be traded downwards to $20/bbl range in 2016 but I guess that should be the bottom as Saudi Arabia will not allow it to go lower than their production cost. Traditionally, gold has an inverse relationship with the dollar, except during financial crisis. I see $1000/oz as the bottom for gold and $12/oz as the bottom for silver. If the global financial crisis breaks out in 2016, gold and silver should shoot through the roof for the next few years. The gold and US dollar will rise together as investors flock to safe haven asset and currency.

That's all for the review. Shane signing off now. Have a great rest of 2015.

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