Commodities & Energy Sector

Global oil demand will continue to surprise to the upside over the balance of the year - growing at a rate of 1.6 MMb/d - following an unexpected surge over the first five months of 2016.

EM/China oil demand is not as strong as some reputable energy sources have indicated. As and when the oil market shifts its attention from supply cutbacks to subdued EM/China oil demand, oil prices will relapse. Renewed drop in commodities prices and poor growth in EM will weigh on EM risk assets going forward.

Gold stocks have regained traction after a brief interlude in the bull market, and the path forward remains bullishly skewed. The Fed took a slightly dovish turn at this week's FOMC meeting, reinforcing that they remain in reactive mode, thereby sustaining rising policy uncertainty (second panel). Given our bias to expect economic disappointment, the odds are good that policy will need to remain accommodative, with real interest rates staying in negative territory for a prolonged period. That is a plus for a zero yielding asset such as gold. With world economic expectations continuing to grind lower (shown inverted, top panel), the appeal of owning gold stocks as a portfolio hedge remains attractive, particularly given that sentiment towards the yellow metal is far below prior extremes. Stay overweight.

Increasing uncertainty over the Brexit vote will keep the Fed from raising its overnight policy rate at this week's FOMC meeting, but it may not keep the USD from rallying in the event of a decisive win for Brexit advocates on June 23.

The 1990s mid-cycle slowdown is an appropriate analogue to current market conditions. A lower dollar was the key ingredient the easing in monetary conditions that resolved this episode. This suggests that today, as the sole economic lever left, the greenback has further downside. Go short USD/SEK. Go long a basket of NOK, CAD, AUD and NZD against the USD.

China's 4.7 trillion RMB (~ $720 billion) fiscal stimulus program will be more bullish for base metals, particularly copper, than we initially surmised.

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All three of Trump's signature policy proposals - increased deficit-financed infrastructure spending, a more restrictive immigration policy, and trade protectionism - are dollar bullish. These policies could cause the U.S. economy to overheat, forcing the Fed to raise real rates more than it otherwise would. Equities could rally in the near term following a Trump victory, but are likely to face stiff longer-term headwinds. Treasurys would still suffer modest losses, while, ironically, the one asset that could suffer the most from a Trump victory is gold.

While the Fed's recent forward guidance leading markets to increase the odds of a policy-rate hike earlier than previously expected will restrain the recovery in crude oil prices, fundamentals will dominate price formation now that markets have rebalanced.

Gold is correcting short-term overbought conditions on the back of a more hawkish Fed and rise in the U.S. dollar, but we doubt any correction will constitute a trend change. The big picture is increasingly shifting toward even more policy unorthodoxy. If central banks ultimately get their way, gold's appeal as an inflation hedge will eventually increase. In the meantime, real interest rates, the opportunity cost of holding a zero-yielding asset like gold, have slipped back into negative territory, and may need to fall further to reverse chronically subpar economic performance. Gold shares can take their cue from balance sheet flexibility (Corporate Health Monitor shown advanced, bottom panel), as increasing rigidness often breeds business cycle and financial market volatility, which boosts the appeal of gold, and vice versa. BCA's Cyclical Gold Indicator has an excellent long-term track record in forecasting gold stock price trends. It is currently signaling that while gold prices may be overbought on a short-term basis, cyclical conditions remain extremely bright (top panel). Keep in mind that gold sentiment is still not overly bullish, despite this year's rally, suggesting that the surprise may be resilience in gold prices and gold stock relative performance on a cyclical horizon. We are sticking with an above-benchmark allocation. The ticker symbols for the stocks in the S&P 1500 gold index are: BLBG: S15GOLD - NEM, RGLD.