Jade Fu, Investment Manager at Heartwood Investment Management, on current opportunities for commodities investors…
Commodities have underperformed both equity and fixed income markets in the year- to-date, with this trend accelerating in the third quarter. A glut of supply and muted demand against a backdrop of decelerating growth in China and a more self-sufficient US have contributed to price weakness across the commodity complex. Even heightened geopolitical unrest in various parts of the world this year has failed to trigger a sustained rally in commodity prices. However, can investors become too bearish in the short term?
Looking at current prices relative to history, some commodities are showing signs of potentially being oversold. Taking corn as an example, its price – along with many other grain prices – has fallen significantly this year, with the spot price nearing a 10-year low. Favourable weather in the US has led to record levels of stocks. Short-term fundamentals are not looking attractive and there does not appear to be an immediate catalyst for this price trend to reverse. However, as suppliers respond to current conditions and given the current price level, the medium-term outlook may not appear so bearish.
Similarly, West Texas Intermediate (WTI) oil has been hurt by ample supply. The commodity has recently broken out of its tight trading range of the last two years and has fallen to around USD91 a barrel. Fundamentally, there appears to be no short-term upward price pressure in WTI; after all, the shale revolution has completely changed the oil trade picture in the US. In 2005, the US was importing 60% of its oil compared with 3% today.
However, as the WTI price approaches its deemed cost of production, the chance of a rebound gets higher, not to mention the potential of a spike up in price driven by unexpected geopolitical events. In the meantime, WTI’s futures curve shape means investors are getting paid a small convenience yield for holding the commodity.
Falling demand in China, as this economy transitions towards a more sustainable level of growth, is primarily driving a less compelling fundamental outlook for the commodity sector as a whole. Nonetheless, there is a high level of price dispersion across commodity indices that might offer opportunities for investors.
