Gold, silver and copper eyeing upside, US inflation report key to US dollar impact

• Commodities are demonstrating an asymmetric reaction to US dollar fluctuations
• When the USD softens, commodity prices often rally hard
• US bond futures may provide a signal on directional risks for USD and commodity prices
• Gold, silver and copper look constructive even before a definitive USD signal

Commodities love USD weakness right now

You can’t help but notice just how sensitive commodities are to US dollar movements right now. Take the price action on Thursday as a prime example with an unusually large increase in US jobless claims sparking big gains across the complex, seeing names like gold, silver and copper push back towards their YTD highs.

The asymmetric reaction provides a sense of how the stronger dollar has acted as a handbrake on commodity prices this year, limiting what may have been otherwise a spectacular rebound. It also makes you wonder what may happen when the strong dollar story breaks apart? If not accompanied by amplified global recession fears, you get the sense commodity prices may fly.

USD heavily influenced by Fed rate expectations

When assessing that prospect, there are worse market indicators to monitor than the front-end of the US bond curve. As this chart shows, the daily correlation between the US dollar index and US two-year bond yields over the past quarter stands at 0.89, implying the dollar usually follows movements at the front-end of the US curve.

When yields drop, so too does the dollar typically, and vice versus.

US 2-year bond futures at key juncture ahead of US CPI

Given the strong positive relationship between the two, I’m paying close attention to moves in US two-year Treasury note futures. I described this instrument as a noise eliminator in a post earlier this week, using it as a filter to gauge trade setups in markets directly involving the US dollar or where the dollar can be highly influential.

As you’re tracking a highly liquid market that measures price rather than yields, I find note futures can combine fundamentals and technicals to get a clean read on directional risks for US rates and FX.

Right now, the jury is out when it comes to whether we’re witnessing a turning point for the big dollar with futures remaining close to key horizontal resistance with the 50 and 200-day moving averages sitting just above. This zone looms as important when it comes to directional risks for the dollar and short-end rates, managing to repel an attempted break higher last Friday following the release of softer-than-expected payrolls and ISM services PMI data.

Source: Refinitiv 

I don’t know what direction futures will break from here. Honestly, I don’t care. But I will be acting upon the signal it eventually delivers.

Should futures break higher, it points to a softer US dollar and firmer risk appetite, as long as not accompanied by recession fears. But should futures reverse course and push back towards the YTD lows, that would be problematic for risk appetite and cyclical assets given it would imply a growing risk of no rate cuts from the Fed this year.

When you look at the macro event calendar next week, you get the sense the US consumer price inflation report may be the catalyst to generate the signal from this indicator. But that’s just a hunch – the signal could arrive from no obvious catalyst at all.

As I wait for the signal on rates and dollar, my bias for commodities such as gold, silver and copper is higher.

Gold looks great

Gold looks great on he charts, continuing to consolidate above former record highs within a broader uptrend. With RSI breaking its downtrend and MACD looking like it may soon crossover from below, momentum looks to be shifting higher once again. Having tried and failed on multiple occasions to break below $2285 in May, that would provide a decent entry level for longs, should the price return there. A stop could be placed below the level for protection.

Alternatively, should the price get a foothold above $2355.10, that too would be a decent entry level, allowing for a stop to be placed below targeting a retest of the 2024 high above $2430.

Silver arguably even better

Silver looks arguably the most bullish market of the base and precious metals covered, breaking out of the falling wedge earlier this month before doing away with minor resistance levels at $27 and $27.75. With MACD crossing over from below and RSI breaking its downtrend, momentum is building to the upside.

Those considering establishing longs would buy now or wait for a possible pullback towards $27.75, allowing for a stop-loss to be placed below for protection. The initial trade target would be the YTD high around $27.75 with the 2021 high of $30.08 located not far above.

Copper coiling and consolidating

Copper sits in a pennant formation within a broader uptrend dating back to February. With RSI breaking its downtrend, momentum may be about to turn higher, pointing to the potential for a bullish breakout of the pennant, opening the door to a possible move beyond the YTD high around $4.70 to a resistance zone starting from $4.82. The 2022 high of $5.04 sits just above.

Should these bullish trade setups play out, I will be using the signal from short-end US rates to determine whether to cut, hold or add whenever it is delivered.

-- Written by David Scutt

Follow David on Twitter @scutty