COMMODITIES OUTLOOK
Inflation Expectations Remain Subdued Limiting Out-performance
(Left axis; absolute change in inflation expectations: right axis; S&P GSCI Index)
-1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5%
Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 SPGSCI Index
Expected Inflation - 5Y
400 450 500 550 600 650 700 750 800
Expected Inflation - 1YR Sources: Cleveland Federal Reserve, Bloomberg, Morgan Stanley Commodity Research
negative. Most indicators suggest we are still in the middle part of the business cycle and have not yet transitioned to a late cycle framework. In fact, despite the apparent breadth of positive commodity performance YTD, the lack of a cyclical transition is clear when one deconstructs the drivers of performance. Natural gas posted large
wheat, nickel and precious metals. Not only are these factors unlikely to push prices higher from here, but many of these factors could prove fleeting and reverse over the course 2014. Energy and base metals should be sectors to watch for a
From a yield perspective, structurally backwardated commodities are most favourable ...
gains on an abnormally cold winter in North America. Soft commodities, including coffee and sugar, surged amid drought concerns in South America. The Ukrainian crisis added a supply or geopolitical risk premium to a number of commodities, particularly corn,
With Spot Returns Subdued, Roll Return
Driving More of the Commodity Return (S&P GSCI Index annual spot return vs. roll return)
20% 40% 60%
-60% -40% -20% 0%
2003 2005 2007 GSCI Spot Return 2009 2011 Roll Return Sources: Bloomberg, Morgan Stanley Commodity Research 12 March 2014 2013
turn in the cycle. In the last three business cycles, these sectors have outperformed other commodities moving into later phases of expansion. Base metals demand is linked to industrial activity and infrastructure investment, both of which tend to accelerate towards the middle of the cycle as capital investment and manufacturing utilization rise. However, as we assess commodity performance YTD, energy
and base metals have actually underperformed other sub- sectors, which merely reinforces our view that commodities have not transitioned to a late cycle framework. Energy and precious metals will likely be most levered to a
late cycle transition. While energy and base metals perform well during the transition from mid-to-late cycle, these commodities tend to be most levered to rising inflation expectations and peaking growth cycles just ahead of an economic downturn.
Dissecting the Last Cycle: Historical Patterns Have Held Historical commodity cycle analysis has held up out of sample. While some argue that financialization has changed commodity performance patterns, historical patterns held in the most recent business cycle (i.e. extrapolating pre-2004 trends to the last decade). From 2005-2008, commodities again proved to be late cycle, narrowly beating equities in the late expansion phase (Jan ’05 – Dec ’07) followed by a 29% out-performance (annualised monthly average) in the early recession phase (Jan ’08 – Sep ’08). During the late recession phase (Oct ’08 – Jun ’09) commodities lost nearly 48% versus 21% for equities. The early part of the recovery has once again favoured equities. As GDP growth has recovered,
Global PMI Improving ... But Not Enough to Drive Out-peformance
(Left axis; JPM Global PMI Index: right axis; S&P GSCI Index)
30 35 40 45 50 55 60
JPM PMI Global Index
-80% -60% -40% -20% 0% 20% 40%
SPGSCI 6 month total return
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
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