COMMODITIES NOW
a policy decision to dampen excessive credit which the authorities could reassess if growth threatened to collapse. For now, policy-makers seem sanguine about weaker GDP growth, especially as the labour market is still strong, but they have the monetary and fiscal tools to support the economy if needed. What’s more, a controlled slowdown now should reduce the chances of a crash landing later. This is also the context in which to view the clampdown on shadow banking: better to allow a few defaults now than to see potential bad debts spiral out of control. • Fourth, any resulting weakness in commodity prices should be a net positive for the rest of the world. Obviously it is bad news for commodity producers and exporters, at least initially, but even they would eventually be worse off if China’s unsustainable investment and credit boom were allowed to continue unchecked. In the meantime, it is good news for commodity consumers, including China itself.
• Finally, we would be wary of interpreting the recent slump in the price of copper as a warning
sign of broader problems in the global economy. This slump has been compounded by factors specific to the industry, such as the impact of the China’s credit clampdown on the use of metals for financing. And as it happens, the Baltic Dry Index of global shipping costs, a rival bellwether, is actually rebounding again. (See Chart 2.) However, we would put more weight on direct evidence from economic indicators such as the global PMIs, which have held up pretty well.
After watching commodities take a hammering
over the past three years, investors may want to consider carefully treading back into the sector, heralding the potential return of commodities as an investment class worth taking a closer look at. However a word of warning; many of the these current bullish moves are driven by short-term exogenous factors – the weather, Ukraine crisis and the like. “There’s the imminent danger of a correction once that situation stabilises,” according to Ole Hansen, Head of Commodity Strategy, Saxo Bank. Since the consensus view is that global GDP
growth is poised to accelerate in 2014, this historical trend may bode well for commodities this year. And looking at the history of bear markets for commodities suggests that the worst could be behind us in the current bear market. The momentum is there but its not a constructively
strong move by investors into the asset class as yet. “While the current bear market has been tough
for commodities, we believe that for us in our role as investment managers, to abandon the asset class could prove to be short-sighted. Not only could we miss a potential upturn, but we could lose out on the inflation-hedging benefits that commodities
have historically provided to portfolios,” says Wolle. “Taking advantage of the current market environment is a natural thing to do when positioning a portfolio, but for us it is important to maintain a diversified core that can help provide resiliency against unexpected events.” For example, as the US Federal Reserve (Fed) plans
its exit from aggressive monetary policy, it’s not clear exactly what the effects might be and what could possibly go wrong. Might the Fed taper its asset purchases too slowly and create inflationary pressures? “If so, we would expect inflation-sensitive assets like commodities to potentially perform well versus stocks and bonds,” Wolle explains. Due to the experiences of the past, combined
with the uncertainties of the future, investors such as Invesco maintain a constructive view of commodities and the role that they can play in portfolios. More specifically, they believe due to their more cyclical nature, commodities such as oil and copper, represent the most attractive opportunities within commodities right now, versus others such as agriculture and precious metals. The 2014 outlook for the world economy remains
more positive than for many years, with an upswing in the developed economies and decent growth in China. Typically, this is an environment where commodity prices do well. However, raw material supply in metals, energy and agriculture remains plentiful, following a strong investment cycle in the preceding years. “As a result, global demand
The 2014 outlook for the world economy remains more positive than for many years ...
needs to accelerate further to break supply shackles. Nevertheless, with prices doing their best to limit future supply investment, underlying fundamentals in upcoming years are starting to look incrementally more positive,” according to Macquarie. Moreover, roll yields will likely be a greater driver of commodity returns going forward. Morgan Stanley commodity experts continue to see value and diversification through the inherent nature of the asset class and its later cycle nature [see next page]. While spot returns may not offer much incentive, investors can capture healthy yields through the backwardation present in certain commodity curves. More active strategies can seek to maximize this yield, even when the front is in contango, and limit spot price risk. As ever, the news out of China will set the tone for
the rest of the trading year. •
www.commodities-now.com March 2014 9
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