U.S. rate hike could weaken commodities

The U.S Federal Reserve’s current accommodative stance isn’t necessarily dovish.

So says Scott Vali, formerly vice-president, Equity, for CIBC Asset Management.

A rate hike is coming soon, he predicts, and it could have direct implications for emerging market growth. “Emerging market fund flows will look for the best return on the margin and, to the extent that is coming from the U.S., funds will flow back to the U.S.”

Read: Economic recovery riddled with risks: Russell Investments

Asia is particularly vulnerable, says Vali, since many of its countries are seeing a significant drop-off in investor interest—there have been dips in China, Malaysia and Indonesia. Central banks in those regions have started to spend their currency reserves to help shore up their currencies and offset fund outflows.

Read: Fed worried about lag in China, emerging markets

Plus, “the outflow of funds has led to credit tightening in these countries. That leads to a slowdown in domestic consumption,” and will impact overall growth in Asia, he notes.

Read: Central banks running out of options

This slowdown could weigh on global commodities by skewing supply-and-demand balance, adds Vali. To hedge against this, he and his team are positioning themselves in commodities where longer-term demand is expected to continue rising, and supply will deteriorate at a faster pace than demand.

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Focus on oil

Global deceleration will likely dampen demand for basic resources like iron ore, coke, coal and copper. But oil may prove more resilient, says Vali. “We look at oil and think it’s a fast-cycle commodity [because] there is natural decline associated with its production. Every year, the globe has to produce four to five million barrels just to replace what has been consumed.”

Going forward, he adds, “[We’ll] need a higher price to incentivize the production of those four to five million barrels of oil.”

Read: 4 ways cheap oil helps emerging markets

So, even though markets continue to be overly pessimistic about oil, Vali expects an eventual price correction. “Oil prices will move higher to [support] future investment, and meet the demand that will still be there.”

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