Ritesh Jain, chief investment officer at Tata Mutual Fund, is not bullish on commodities in general this year, but says that gold gives him hope.
Blame it on the strong dollar with its deflationary effects or the tranche of weak economic data out of China or lackluster numbers in the U.S. outside of the recent payroll boom. There seems to be little going for commodity prices.
Investments were done in commodities and energy - natural gas (2007), base metals (2011) and recently oil, with most of the capex done by taking on debt, a substantial part of which was dollar denominated. Most spending was concentrated on factories and projects unlikely to meet their cost of capital in the low commodity price and slow trade environment. With a surge in the global economy doubtful, it’s unlikely commodity prices will rebound in 2016. Recently, the Baltic Dry Shipping Index, an indicator of economic activity, touched an alltime low; crude oil crashed 40% from its 2014 highs; the Bloomberg Commodity Index dropped 25% - its fifth straight year of declines; copper fell 25%; platinum 30%, wheat 20%.
Oil: Lower for longer?
Who would have projected $30/barrel crude?
By a kind of irrational logic, the cure for low prices is low prices. We could see oil in the $20s before we see it back in the $50s. With the kind of currency depreciation that we have seen in the EM currency basket, petro-dollars converted back into the local currency still means good realizations in home currency. Let’s put it in perspective. The Brazilian Real and the Russian Ruble dropped around 60% and 20% in 2015. In local currency terms, Brazilian exporters are still clocking higher revenues than during the start of the year at a higher crude! As a Brazilian energy exporter, why would I drop production in the wake of lower global crude prices? I am bearish on energy and specifically crude oil. My view is driven largely by continuing supply (production + inventory) exceeding demand over the next year with an agreement to cut production eluding the powerful OPEC cartel. Add to that the U.S. lifting a 40-year ban on export of crude oil and sitting on record inventories, some of this oil will flow into the global oil market.
Another aspect is petro revenues in local currency terms. Brent crude closed 33% lower this year in dollar terms. With suppliers refusing to cut production, the spigot of oil is unlikely to close soon. On the other hand, U.S. shale gas, with its standard and repetitive drilling could come as a supply shock for which OPEC is not ready for. Any supply shocks arising out of violence in the Middle East could spike up oil price volatility. Other than that, I remain bearish on oil.
Agri Commodities: Currency is the key
Global agricultural commodity prices are down 5-20% in 2015 on account of record production of grains and oil seeds from South America. Last year saw the dollar rally bringing about deflation in agri-commodities. The Brazilian Real, Ukrainian Hryvnia, Russian Ruble depreciated substantially against the dollar in 2015. Brazil is a large agri commodity and energy exporter- constituting roughly 40% of its overall exports. The economies of Ukraine and Russia are primarily dependent on gas and agricultural exports. With a larger proportion of agricultural commodities now produced outside the U.S., the link between low market prices and production cuts has been broken as weaker local currencies provide an incentive to expand output for these countries.
On the demand side, there is little chance that China will act as an exogenous source of additional commodity demand to stabilise prices. The risk to lower agricultural prices could come from weather related vagaries with one of the strongest El Nino on record affecting sugar, cocoa, palm oil and coffee crops. Netnet, we could see weather induced supply shocks being counter balanced by currency moves. I would look out for opportunities in agricultural commodities as they seem to be forming a base.
Metals
Metals are broadly divided into base and precious metals.
Gold is a hedge against non-coherent and flawed central bank policies and their outcomes and macro instability. Gold looks to be emerging from a 3-year bear cycle when it sunk to $1,050 from $1,900 levels. 2016 started with both gold and the USD rising simultaneously. The rise of both may signal that we have just entered that period when this inert non-yielding investment is preferred to assets that promise a yield but where the scale of future payments is subject to considerable doubt. This year may mark the world’s disenchantment with loose money policies of global central banks and lure it towards gold. Gold is also a hedge against currency risk and with EM currency volatility being an overarching theme in 2015, I believe that the allure of gold as a hedge against central bank policies (follies?) could mean we might see investors turning to gold as a safe haven. The risk here is a stronger than an expected dollar rally. This could derail gold’s progress.
For base metals, the Chinese economic slowdown and the country’s rotation to a more consumer-oriented economy from direct investment have been big headwinds to base metals demand and sentiment. With 40-50% share in metal consumption, China has been responsible for a very large portion of incremental demand for commodities in recent years - copper, oil or pretty much all industrial commodities. With a Chinese sharp bounce back unlikely in the near term, I do not see base metal prices rebounding sharply from current levels. A stronger dollar and continued low global inflation, both of which have weighed on commodities in 2015, are likely to remain headwinds going forward.
To sum up…
The trinity of dollar-crude-China will shape the global pricing of commodities and the general health of the world in 2016. Gold is getting disengaged from the commodity basket and holding on its own. The natural state of the world is deflationary, and this extends to commodities also.
I would not be bullish on commodities in general in 2016 but gold gives me hope.
The views of the author are personal and not necessary those of the organization he represents.
The above column has been taken from the online publication of India Markets Observer. The outlook for various asset classes, perspectives on the industry, investing insights, and the entire list of contributors, can be accessed here.
