COMMODITIES OUTLOOK
With Spot Price Performance Limited, Roll Yields Will Likely Be A Key Driver of Returns As noted earlier, we expect roll yields to
drive much of the return in 2014. This simply continues an emerging trend from the past several years. Spot performance of the GSCI has been on the decline since 2009, and we expect
gains to be limited until the global economy enters a later cycle phase. That puts an emphasis on roll yields to drive returns. In 2013, the S&P GSCI spot index lost 2.2% while its roll return was nearly 1%, the highest since 2003. Moreover, with backwardation increasingly common in the
MS Commodity Sector Preferences, 2014 Livestock Grains Energy Softs Base Metals Bulk
Precious Metals
Tight supply and long production cycles should continue to support livestock prices well into 2H before new supply and lower feed costs begin to weigh.
Better than expected demand, particularly for corn, should remain supportive in the coming quarters, though strong production will likely once again pressure prices in 2H
Oil supply growth should modestly outpace demand, requiring OPEC to cut production. Natural gas supply growth will necessitate lower prices to incentivize power demand.
Risks to sugar look balanced as current prices begin to encourage cutbacks in production. The impending removal of Chinese price supports should prove bearish for cotton.
Except for copper, prices across the complex are trading at or below marginal cost—a reflection of oversupplied markets.
Iron ore and coking coal still supported by Chinese steel demand, but remain well supplied. Thermal coal is pressured by cheap US gas.
Little upside to the gold price this year as the gold market is fully priced for a turn in the US interest ra
te cycle. PGMs to
outperform on favourable supply dynamics and physical demand strength.
Source: Morgan Stanley Commodity Research Palladium, Platinum & Corn Screen Well on Market Fundamentals (MS assessment of fundamental factors)
Commodity DM Exposure Consumer Linked
Brent WTI
Dollar Sensitivity
Curve Structure
-+ -+
Natural Gas ++ +- -
Corn -+ ++ -+ Wheat -+ --- Soybeans -+ ++ -- Cotton -+ --- - Sugar -+ --- Cattle -+ +- ++ Gold -+ -- +- Silver ++ -- +- Platinum ++ Palladium ++
-
Aluminum -+ -- Copper -- -+
-+ + -
+
Lead -+ -- + Nickel -+ --- - Zinc ----
+ = positive factor, - = negative factor. Source: Morgan Stanley Commodity Research
Supply Outlook
Fundamental View
Least Preferred
heavily-weighted energy markets, overall benchmark roll yields have improved. The front of the WTI curve – a key benchmark component – has moved into backwardation this year, creating more opportunities for investors to capture positive roll returns.
For Investors willing to risk Most Preferred
prompt month tracking error, there are significantly more opportunities to capture premium or structural backwardation as one moves around the curve. From a yield perspective, structurally backwardated commodities (oil and refined products, soybeans, and corn) are most favourable, while natural gas, most base metals, wheat, cattle and precious metals are generally in contango.
Outperformers: Palladium, Corn, Copper, & Live Cattle The framework we have outlined above can be viewed as a commodity screen for 2014. Nevertheless, each commodity has unique fundamental characteristics and idiosyncratic risks, apart from the macro, that should also be considered. Demand: We favour commodities linked to the re- accelerating, consumer-heavy DM. Palladium screens well here. The agriculture and soft commodities also stand to gain if EM shifts towards internal consumption. Natural gas may screen well, but limited demand growth makes us cautious. USD Exposure: Metals (base and precious) are the most vulnerable to a stronger USD, while grains, cattle and natural gas have very little exposure. Structure: Backwardation offers yield opportunities. Brent, WTI, and soybeans are most promising in this regard while natural gas, base metals, livestock, and wheat screen poorly. More active strategies may be able to better manage this exposure. Supply: We prefer names with limited supply growth and tightening balances. The precious metals, lead, and zinc are most supply constrained, while the supply of agriculture, soft commodities and natural gas is projected to grow considerably.
Our top picks for the balance of 2014: palladium, corn, copper, and live cattle. We are most bearish natural gas, gold and aluminium. •
Adam Longson is global head of
Morgan Stanley Commodity Research.
Adam.Longson@morganstanley.com
With contributions from Bennett Meier & Peter Richardson.
www.marganstanley.com 16 March 2014
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