Highest conviction in oil-based products
As the US economy continues to show signs of recovery and Europe begins to stabilise there is growing sentiment that developed markets will have more of an influence on global commodity prices this year.
This is how David Donora (pictured), co-portfolio manager of the Threadneedle Enhanced Commodities Strategy is positioning the portfolio, with oil and oil-based products – in particular gasoline – forming the highest conviction sectors.
As Donora explains, a growing US economy will lead to increased demand for gasoline. This has already been borne out by the IEA, which said US oil demand rose by 390,000 barrels a day last year, or 2 percent.
“We are overweight products such as gasoline and distillates. This was our highest conviction play for 2013 and we expect it to remain so for 2014 as we expect the US to pick up momentum (economically),” says Donora.
The strategy employs strong bottom-up analysis with fundamental research to identify investment opportunities across energy, metals and agricultural commodities. Expanding on how the strategy is positioning itself with the energy complex, Donora notes that Henry Hub natural gas prices could fall by year-end, as others are forecasting, but it would depend on a number of factors:
“The challenge for the natural gas market in the US this year is going to be replenishing inventories. We need to prove that for the first time in several years, production as well as the infrastructure is capable of rebuilding inventories from a very low level. We would only make that call (on prices falling) if we have benign weather between now and the end of the year and infrastructure in the US is up to the task. That’s an awful lot of qualifications to meet so right now I would say it’s too complex to call.”
Rather, Donora is more bullish on Brent Crude, WTI, gasoline and heating oil whose forward curves are in backwardation; this is where the spot price is higher than prices for future delivery so the curve is inverted.
“We want to capture that backwardation because it gives us the positive roll return. We position ourselves accordingly in the portfolio to capture both aspects: one is the strong flat price and the other is the roll down.”
Donora believes that the economic recovery underway within OECD countries will result in a cascade effect within broad commodities with oil-based energy the first sector to likely experience positive price momentum.
“Next would be soft commodities. Prices have been too low, to the point where they are cutting into the marginal costs of production. That would in turn cause producers of these commodities, who are largely based in emerging market countries, to cut back on husbandry as well as fertiliser usage. We therefore expect to see a dropping off of production in coffee, sugar,” says Donora.
The third commodity complex to move will likely be grains, followed by base metals and precious metals, says Donora, who elaborates on why precious metals by commenting:
“Investors who were sitting on gold as a safe haven asset are re-evaluating their position and looking to redeploy assets. Usually this is expressed by investing in dollar-based economic activity: US bonds, equities, and infrastructure projects.
“This is a tactical investment shift that we’ve seen happening over the last 12 months and will continue as we believe the US dollar will strengthen for the next few years.”
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