Commodities – Time To Start Reloading by David Donora, ColumbiaManagement
- Base metals, U.S. natural gas, grains and now oil are all trading at price levels that are signalling producers to cut production.
- We see the over-production of oil as temporary and the market balancing in Q3 2015, and while this will leave significant inventories to work through, prices should recover into year end.
- In our view, commodities in general, and the energy markets in particular, offer good entry points as we head towards better growth and tighter supply and demand balances.
There is value in the asset class on a relative price basis. Exhibit 1 shows the trading range, since the start of 2000, of all the commodities found in the Bloomberg Commodity Index. The solid part of the bar is the current price level, with the diamonds representing the average price of the last five years.
Currently, almost every commodity is trading significantly below its average of the last five years, and is also below the 35-40% range of the past 15 years.
Exhibit 1: Almost every commodity is trading significantly below its five-year average
Source: Bloomberg, Threadneedle. February 2015.
The market has been in a downtrend for over four years, and oil was the final commodity to capitulate. Global oil inventories are likely to continue building until mid-year by which time supply and demand should rebalance. Therefore, it is possible oil markets could retrace some of the short covering gains while negative headlines from Ukraine and Greece could also weigh on commodity prices in general in the short term.
Exhibit 2: Bloomberg Commodity Index, total return
Source: Bloomberg, Threadneedle. February 2015.
Macro drivers, led by improving OECD growth
European growth is finally beginning to improve, supported by a weak euro, ECB QE, positive credit growth and low oil prices. Threadneedle Asset Management (TAM) is forecasting 2015 eurozone gross domestic product (GDP) at 1.5% versus 0.3% in 2014.
U.S. economic growth continues to look robust with wages and the labor market beginning to gain traction. TAM is forecasting 2015 U.S. GDP to increase 3.0% versus 2.4% in 2014.
China’s economic reforms and transition from poor-quality but rapid fixed-asset investment growth to more sustainable consumer growth is beginning to show signs of working. This will be supportive for some key commodities such as base metals and energy.
Commodity drivers
Base metals, U.S. natural gas, grains and now oil are all trading at price levels that are signalling producers to cut production. This is coming at a time when global growth is starting to accelerate, consumer income is improving, and spare capacity in metals and energy is low.
We see the over-production of oil as temporary and the market balancing in Q3 2015, and while this will leave significant inventories to work through, prices should recover into year end.
With base metals in deficit positions or balanced, there is little space for increased demand before prices increase significantly. Production growth in the short term is very limited due to multi-year cuts to capex and exploration, with some inventory levels down 50% over the last 1-2 years.
While grains and oilseeds have replenished inventories, the U.S. is cutting crop acreage for 2015, and these markets are only one weather hiccup in any growing region away from significant price increases. Production of corn is marginally profitable in the U.S. and Brazil, so inventory levels are likely to stabilize around current levels.
In our view, commodities in general, and the energy markets in particular, offer good entry points as we head towards better growth and tighter supply and demand balances.
Commodity investments may be affected by the overall market and industry- and commodity-specific factors, and may be more volatile and less liquid than other investments.
Threadneedle International Limited is an FCA- and a U.S. Securities and Exchange Commission registered investment adviser based in the UK and an affiliate of Columbia Management Investment Advisers, LLC.
