On the sixth of July, I wrote an article about a great Cliffs Natural Resources (CLF) long opportunity. At this point, we are seeing further help from an unexpected driver. In addition to stronger economic growth and the possibility to get domestic steel protection, we are seeing that the USD is seriously weakening. In this article, I will explain why this is great news for Cliffs.
First, let me explain why a weaker USD is very bullish for commodities. Industrial metals (JJM) especially benefit from such depreciations. This can be explained in a few sentences. The first reason is that a weaker USD makes commodities relatively less expensive for commodity sensitive countries that buy large quantities of certain cyclical commodities. Add to that the massive USD debt load since the recession. Countries used the cheap interest rate in the US to fund operations. This means that their debt load eases a bit which adds to current and future operations.
One of the reasons for a weaker USD is higher international growth. High growth sends money into cyclical assets. Many of those assets are emerging markets and cyclical industries like mining and steel companies. That being said, we are seeing growth acceleration in emerging and developed markets as you can see below.
The leading purchasing managers indices are showing acceleration since 2016. Developed markets gained steam while emerging markets left a long period of contraction and started accelerating.
This has been one of the reasons of global currency gains against the USD as you can see in the overview below.
So far, all of this has led to a commodity rally. The iPath Bloomberg Industrial Metals Subindex (JJM) has bottomed in Q1 of 2016, backed by higher economic growth and a weakening USD.
One very important thing to note is the lower USD/commodity correlation since the second half of 2016. This is mainly caused by the so called ‘Trump effect’. Trump is promising infrastructure spending, tax reforms and import tariffs. This is bullish for the US economy and a driver behind the USD. At least, that is what traders have been pricing in as you can see in the fourth quarter of 2016.
The Cliffs chart is confirming all of this. In the long term, we see that every single major move has been supported/led by the USD. The big rally after 2002 for example started with a massive USD depreciation.
This means that the current USD breakdown (inverted graph) could massively add to the momentum of this beautiful iron ore stock.
Note that the biggest USD component, the euro, has already broken out of a 2 year sideways trend – hence the title of this article. Add to this that this move is not only due to higher growth. It’s also because of higher odds of rate hikes in various major currency regions. The Bank of Canada, Bank of England and the European Central bank have taken a more hawkish stand recently. Even though they have not increased rates yet.
• The Bloomberg euro index gained about 1.6% for the week after Draghi said Thursday that discussions will begin on adjusting QE programs at meetings during the fall, though he steered clear of setting a firm date; his actions came after weeks of speculation that such a shift was in the works and the euro rallied on the confirmation
• Draghi said that the ECB remains far from achieving its mandate to get inflation close to, but below 2%, though he indicated that an improved economic outlook will feed through to wages and then prices; those expectations have also been expressed by the U.S. Fed, which is about to embark on its own tapering program, though it too finds its inflation objective elusive
• Amid policy setbacks that have delayed President Trump’s plans for fiscal stimulus, traders have pared bets that the Fed will raise rates again this year, despite recent assertions from officials; the Fed meets next week to decide on policy and investors will parse its policy statement for any shift in tone or sentiment
Source: Bloomberg (picture and 3 bullet points)
The USD bull case has gone from showing minor cracks to a full breakdown. All major currencies are gaining steam or breaking out compared to the world’s main currency. This is backed by higher economic growth in all economic regions and hawkish talk in the euro area, Canada and Great Britain.
This adds to the momentum of Cliffs since it is an iron ore minor that benefits both from higher economic growth and a weaker currency. I am happily long and look forward to add some shares in the current minor dip.
I highly recommend reading my first article since it discusses Trump’s policies and the return of the reflation trade: Cliffs Is About To Explode.
Thank you for reading my article. Feel free to share your thoughts and to ask questions in the comment section below.
Disclosure: I am/we are long CLF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.