In the past decade, China has been the main driver of commodity prices as it experienced an economic boom. The country accounts for more than 30 per cent of the world’s base metal consumption and is also a primary consumer of soft commodities such as soybeans.
But in the past three years GDP growth has slowed into the single digits, as the Chinese government has looked to rebalance the economy away from infrastructure projects towards a more consumer-driven model.
When it was revealed China’s gross domestic product had fallen to 7.7 per cent in the first three months of this year, commodity prices tumbled, including oil and base metals, while the Dow Jones fell by 250 points.
The most high profile victim of this weakening market has been the gold price, which experienced its furthest drop in 20 years in April.
The precious metal has been in a bull market for several years as it was perceived to be a ‘safe haven’, as a hedge against spiralling inflation. But the economic environment became less favourable for gold, as a combination of panic created by the possibility that Cyprus will reduce its deficit by selling its gold reserves and fears the US could exit their programme of quantitative easing early led to a rapid deterioration in investor sentiment.
On April 10, Goldman Sachs slashed its forecasts for gold, and recommended investors should make negative bets on the precious metal in anticipation of the price slump, although the investment bank recently closed that recommendation and is now advising clients to close out their bets at the current price.
These underlying concerns also took their toll on crude oil prices, which analysts said have been trading at “unsustainably high” levels.
“Currently, brent oil is trading on about $100 per barrel compared to $112/bbl a month ago” Charles Stanley analysts including Jeremy Batstone-Carr noted at the end of April, citing “weaker global growth” as the reason for the price fall.
Analysts at Capital Economics agree that economic weakness was a negative driver of prices, and argue $100 a barrel would be the top end of the pricing range going forward. “The recent weakness in the cost of crude supported our view that oil prices have been unsustainably high given the fragility of the global economic recovery,” they explain.
“In the next few years we continue to expect $100 to be seen increasingly as a ceiling for Brent, rather than the floor that many others assume, with the global benchmark ending the year below this level and falling further in 2014.”
But some managers see this weakness as an opportunity to take a contrarian approach, increasing more exposure across the commodity sector in the belief of a renewed rally.
Peter Walls runs the Mastertrust fund of investment trusts at Unicorn Asset Management. He sold out of BlackRock World Mining last year after he “got nervous” about the commodities sector.
“It’s proved to be beneficial. Commodities funds haven’t done at all well,” he says.
But Mr Walls is now considering returning to the sector because he sees the opportunities as too good to ignore. “Gold and mining are volatile. It’s a rollercoaster ride, but I’m warming to the idea”, he states, citing City Natural Resources investment trust, which is trading on a discount of roughly 19 per cent and has a big gold exposure, as a potential investment.
ETF Securities analyst Nitesh Shah agrees that the weakness in commodity prices is short term. “Most commentators are in fact referring to the near-term outlook for a few specific commodities rather than the longer-term trend that characterises a super-cycle.”
Neil Gregson, manager of the JPMorgan Natural Resources fund, suggests that diversified miners in particular looked set to benefit from a price rebound.
“In the next 12 months economic drivers will generally be improving. Obviously there has been a weak start but we don’t believe that will last. Valuations look very attractive and sentiment is very poor,” he explains. “All the ingredients are there, particularly for diversified miners such as iron ore and copper because they outperform oil and gas in a global growth environment.”
Mr Gregson adds that China still looked set to be a key driver of commodity demand. He says: “People are hung up on infrastructure, which is more commodities-intensive, but they [the Chinese] haven’t stopped spending.”
Eleanor Lawrie is news reporter at Investment Adviser
Hot or not?
Russ Koesterich, BlackRock’s chief investment strategist:
“In the aftermath of the recent sell-off in gold, investors have been taking a closer look at commodities to see if there are any bargains available. Oil prices, in particular, have been a focus and while oil has declined in recent months, prices have been inching higher more recently and are above the $85-per-barrel level.
“We expect energy prices to be range-bound. While global demand is growing, so too is production. We would expect oil prices to remain in a stable range between the high $80s and the mid $90s, absent a supply shock in the Middle East, which would arguably drive prices higher.”
Ivo Kovachev, co-manager Johcm Emerging Markets fund:
“We are very underweight commodities stocks given uncertainty about the strength of the supercycle.”
On the fence
Nicholas Brooks, Head of research and investment strategy at ETF Securities:
“We appear to be at a turning point for commodities, with the bullishness towards cyclical commodities of the first 10 weeks of the year having been given a shock by the near-default of Cyprus in the latter part of March.
“Since the Cyprus deposit confiscation, gold inflows have resumed (albeit tentatively) and flows into more cyclical commodity exchange traded products have slowed or reversed. How Europe deals with Cyprus and potential contagion to other peripheral European economies, and the sustainability of strong growth data from the US, will likely decide whether the recent reversal in the rotation out of gold into cyclical commodities is the beginning of a new trend or just a pause before the cyclical bull run continues.”