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Asserting fundamentals over sentiment

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By Nitesh Shah (pictured), ETF Securities – The commodity cycle is turning. Excess supply is being cut back across a broad range of commodities. While it will take time to reduce surplus stock, the trend is now set in the right direction. Sentiment however, remains stubbornly negative as multiple years of poor performance has jaded investors. We assert that if sentiment starts to realign with fundamentals there maybe scope for strong price gains. Exchange traded products (ETPs) allow investors to capitalise on such investment themes.

There are plenty of examples within the commodities space where sentiment and fundamentals are currently misaligned. Take industrial metals. Although fundamental conditions appear to be tightening for a range of industrial metals, other factors are keeping gains in check. A strengthening US Dollar and concern over Chinese demand are having a restraining affect, but we expect the influence of these factors to fade over the coming months. We think those fears over dollar strength and weak Chinese demand are overdone. Strengthening of the US Dollar only comes in the context of a strengthening US economy – something that bodes well for industrial metal demand. China's commodity imports have been resilient despite the lacklustre economic performance so far this year. We see the country's demand for commodities increasing as the postponed infrastructure spending from last year gets accelerated.

Weak prices tend to generate demand, in turn helping prices to strengthen. The oil market is an example of this dynamic in practice. Following a glut in supply after OPEC abandoned its previous policy of trying to balance the market, oil prices more than halved between June 2014 and March 2015 and US oil rigs in operation fell by 60 per cent. Investment in oil production elsewhere has been slashed. A recovery in prices between March and June this year threatened to undo some of the production cuts that we had expected. US oil rigs rose in response to the increase in price and producers elsewhere remained vague about how exactly they will cut back.

However, prices have declined once again in recent weeks, pressing high-cost producers (primarily non-US, non-OPEC) to cut investment. The dearth of investment today will mean that high cost production, particularly deep-water and capital intensive conventional oil production that was expected last year, will fail to come to market and therefore tighten the supply-demand balance. At the same time weak oil prices have spurred demand from developed and developing countries. Once again we are moving toward a supply-demand balance.

There are plenty of examples beyond industrial metals and oil which highlight the misalignment between sentiment and fundamentals. Sentiment is fickle and if history is a guide, negative sentiment could shift suddenly, potentially giving rise to sharp price gains.

Commodities are one of the largest markets opened up by ETPs, allowing investors to buy anything from industrial metals to grain without worrying about the logistics of storage, transport and insurance. 

Frank Spiteri, Head of Retail Distribution, ETF Securities, says: “The advent of commodity ETPs has revolutionised the way in which investors access commodity markets, providing a variety of investors with exposure to both physical spot and future commodity returns. ETPs have seen tremendous growth since their European debut over a decade ago and we expect the retail market share to continue to grow steadily as more intermediaries look to introduce clients to ETPs.

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