CommoditiesDec 12 2016

Good things come to those who wait

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Good things come to those who wait

At the start of this year, it looked like commodity markets could not go any lower. Despite another plunge at the start of 2016, those who remained invested in commodities have been rewarded.

It has been a particularly dramatic year for investors in oil, with the price of Brent Crude at around $27 a barrel in February, only to have recovered to $47 a barrel by early September. It has remained around this level ever since.

The reason for this rebound was the expectation that Opec would come to a deal among its member countries to curb oversupply of the commodity, helping boost prices to above $50 a barrel. This eventuality duly occurred at the end of November.

Aneeka Gupta, equity and commodity strategist at ETF Securities, explains: “Optimism over Opec’s production cuts helped boost oil prices during the initial part of the year. However, Opec’s commitment is contingent on the participation of non-Opec countries. 

“Large non-Opec members such as Russia, Brazil and Kazakhstan are seeing new production come online as a result of investment put in many years ago. There are also a large number of Opec countries looking for exemptions from participating in production cuts, placing the burden on countries like Saudi Arabia and other Gulf Cooperation Council members.”

She believes oil will continue to trade in the $40-55 per barrel range “until visible signs of a production cutback emerge”.

For Neil Gregson, manager of the JPM Natural Resources fund, there are other reasons to be optimistic about oil.

“Over the short and medium term, we think oil prices will trend higher from current levels. Demand is still robust, not just from the US but from Asia. Capital being cut by oil companies will ultimately have an impact on supply, serving to tighten supply/demand dynamics,” he reasons. 

“Underinvestment from across the industry will gradually lead to supply becoming more constrained, coupled with the fact that the oil sector loses 4 or 5 per cent of barrels per year just through natural decline rates. Lower prices have also taken their toll on supply and, as prices have declined, demand growth has responded well.”

Overall, 2016 has been “a better year” for commodity prices, observes Tom Nelson, head of commodities and resources at Investec Asset Management.

“Many of the key physical commodity prices have moved higher (crude oil, iron ore, gold), which has driven outperformance from natural resource equities and improved confidence in the sector,” he notes. 

“Commodity prices have become less correlated and we believe this will present investment opportunities in the coming year for the specialist investor.”

Mr Nelson points out: “Commodity producers have done a lot to help themselves. Cost-cutting, reduced investment, asset disposals, debt reduction and a clear focus on returns rather than growth have enabled companies to capitalise on a more supportive backdrop than we saw in 2015.”

The so-called ‘safe haven’ asset of gold has also had an unpredictable year. Gold is generally used in a portfolio as a hedge against other asset classes but it did not fare so well in the aftermath of the US presidential election.

Capital Economics notes that after an initial jump from around $1,280 to $1,338 per ounce on November 9 as the election results came in, the gold price then dropped back to $1,225.

Alistair Hewitt, head of market intelligence at the World Gold Council, explains retail investors usually buy into gold on price dips rather than when they see a dramatic increase in the price.

He recalls: “The gold price fell from the end of September through to the middle of October and that proved to be a bit of a buying opportunity for a lot of retail investors.”

He cites another interesting period of gold buying among investors earlier in the year: “Before the EU referendum we saw significant buying from people within Europe but also the mainland UK looking to hedge against some of the risks surrounding Brexit, some of the uncertainty, and gold in times of uncertainty is a tried and tested asset for people to flock to.”

Mr Hewitt suggests: “The investors who did would have been very pleased with their investment. The subsequent collapse of sterling boosted the sterling price of gold to incredibly high levels, to the extent that even though we’ve had the price dip the sterling gold price this year is still up 35 per cent because of the weakness of the pound as a result of Brexit.”

Ellie Duncan is deputy features editor at Investment Adviser