Are commodities now a source of value?


David Donora, Head of commodities at Columbia Threadneedle Investments

On the macro front the central banks have been doing a good job of incentivising investors to increase their weightings in commodities, notably holdings in hard assets, with gold being the first and prime beneficiary. A massive 500 tonnes of gold have been added to ETF holdings this year, and as interest rates around the world sink further into negative territory, investor commodity demand should continue to escalate. If the monetary experiment doesn’t deliver results, fiscal stimulus could begin on a global scale.

Already, employment and wages are growing, and combined with the years of low commodity prices, consumers are finally resurfacing and beginning to breathe. Fiscal stimulus should help Main Street and consumers, and combined with improving emerging market growth and a relatively weaker US dollar, commodity prices should finally benefit from a tailwind rather than facing a headwind from macro forces.
Underlying commodity fundamentals have also been improving, especially on the supply front. A feature of the prolonged period of low commodity prices has been the significant cuts in capex, especially in energy and mining. Essentially, this brings forward the point at which global demand outstrips supply and compromises the supply response to higher prices.


Globally, crude oil supply and demand are back in balance, especially relative to the period starting early 2014 where production began to outstrip demand by 1.5 million barrels per day (mbpd). North American production has been falling since the middle of 2015, and is expected to fall significantly this year, while global demand, having increased by nearly 2mbpd over 2015, is on target to increase by a further 1.3mbpd in 2016.

Resurgent emerging market economies should drive oil demand faster than market expectations – strong investor flows into emerging market equities and debt over the last quarter supports this view. Global oil inventories should start drawing significantly towards the end of this year and continue to do so through 2017. The key question is what the supply response will look like.

Already this year, zinc has rallied over 40 per cent, nickel 17 per cent and aluminium 10 per cent. It has been a strong start for base metals and fundamentals are continuing to improve, however, base metals only make headlines when copper is in play. So far this year, there has been incremental copper production and a low level of disruption that has kept the price subdued. Over the next six months copper fundamentals will significantly improve and base metals across the board, led by copper, will see higher prices.

With respect to agriculture, the transition out of a benign El Niño phase increases the risk of crop threatening weather which would tighten the supply and demand of grains and oilseeds. Erratic weather resulting in weak grain harvests in both Argentina and Brazil mean that the expected bin-bursting North American harvest is absolutely necessary to maintain reasonable buffer stocks. Any shortfall will force price rationing of demand.

Historically, commodities have been uncorrelated to equities and negatively correlated to bonds, and as such provide a meaningful diversifier in a balanced portfolio. We are now at the point where the supply/demand dynamic is rebalancing across commodity sectors, the value argument is there, and the macro forces are increasingly supportive.