Commodities Market Outlook by ColumbiaManagement
In the following Q&A, David Donora, Head of Commodities for Threadneedle Investments, addresses some of the key concerns currently facing investors in commodity markets, and explains his view of the outlook for the market.
What is your outlook for commodities for the remainder of 2014?
We are bullish on the macro outlook for the rest of 2014. The OECD countries and in particular North America, the region where economic growth is currently the strongest, and where growth is accelerating, will drive the expansion. Unless there is a significant escalation of geopolitical events we expect global growth to improve. Given that the developed world is leading the global economy, we anticipate that the expansion will be more energy intensive, and less intensive in terms of its consumption of industrial-type commodities, than if it were led by the emerging economies.
Could you elaborate on developments in the energy complex, including how the Iraqi conflict is affecting oil and how the situation in Ukraine is impacting natural gas?
We anticipate that the price of Brent will remain high at about $110 to $115 a barrel by the year end. We also foresee a continuing dislocation between Brent and West Texas Intermediate (WTI) with the latter continuing to trade at a discount of around $7-$15 a barrel to Brent.
In terms of curves this means that we expect Brent to remain in backwardation, that is to say that the prices for immediate delivery will be higher than the prices for oil five to 10 years ahead, and similarly in the short term we recognize that prices for WTI will also be in backwardation. But as oil production continues to increase in North America, we would expect to see that curve eventually flatten out.
Interestingly, when these curves are persistently in backwardation, as in the case of WTI, they tend to be a little bit more volatile than we would otherwise expect. We are seeing this phenomenon across the entire commodities spectrum. Markets are more prone to backwardation and we are long past the time of supercontango (an extreme case of contango, which is when the future price is below the current spot price). For the first time in nearly 10 years, the roll return on commodities is consistently positive.
Year to date, as of June 27, the positive roll return on the Dow Jones UBS Commodity Index was significant at +1.7% and reflects the changing shape of the commodity curves. This in turn reflects underlying demand as well as supply challenges across a number of markets, most notably energy.
Could you elaborate on how you see the natural gas market developing?
Natural gas is a component of the Dow Jones UBS Commodity Index but it is not a unified global market. Thus, the price of U.S. natural gas has no bearing on the price of international natural gas because the U.S. is unable to export natural gas into the global market. Consequently, developments in the Ukraine, for example, have no bearing on the U.S. natural gas market. The European natural gas market certainly is affected, however. But overall we believe that Europe and Russia’s interdependence is too great for there to be any long-term impact from the problems in the Ukraine, where we anticipate that the situation will be resolved diplomatically without any serious disruption to supplies from Russia into Europe. However, it could easily take the remainder of the year or longer for the crisis to be resolved.
What is your view of base, industrial and precious metals?
At the sector level we are positioned in line in base metals, as opposed to oil-based energy where we are as overweight as possible. Although we have a market weighting overall in base metals, we are significantly overweight lead and nickel and underweight copper and aluminium.
We believe lead and nickel face challenges in terms of supply and supply disruption. Lead is often mined as a by-product of gold and silver and as there has been a significant decline in the price of both precious metals, lead production has been under pressure. The price of nickel, meanwhile, has gained support from Indonesia’s decision in January to implement a ban on the export of a range of mineral ores. We expect the upward pressure on prices to continue for some time.
While we hold overweight positions in some sectors we have to hold underweights in others, since we are always fully invested in commodities. Our significant underweight in copper and aluminium results from the negative news flowing from China, whether it concerns the economy, the housing market or the financial sector. Prices are unlikely to pick up until this negative newsflow abates and there is a change in the demand dynamic in China.
However, we would expect that our underweight stance on copper, which we have held for over a year, will have run its course by the end of 2014. Indeed, longer term we believe that China will resolve the problems facing the economy and that we will consequently adopt a positive view of copper prices at some point in 2015.
We also remain underweight in aluminium because there is a significant amount of