For the first quarter of 2011, positive investor sentiments, a weaker US dollar and increased demand from emerging markets supported the rally in commodity markets. However, in recent weeks amidst fears of a double dip recession and the decline of investor sentiments, the rally in commodity markets stalled. Weaker than anticipated growth in the world's largest economy, the United States, and monetary tightening in emerging markets, contributed to a slowing of global economic activity and renewed fears of a double dip recession. Additionally, there was a decline of investor confidence as a result of the sovereign debt woes of the advanced economies, the United States credit downgrade and the continuation of the Euro-zone debt saga.
The Thomson Reuters CRB Index, which tracks the performance of a basket of commodities, reflects the general trend in commodity markets.During the first five months of the year, the CRB Index performed favourably, peaking in April owing to the rally in commodity markets. However, with the decline of commodity prices, the CRB Index fell into negative territory in May. Currently, the CRB Index recorded a modest year-to-date gain of 0.43 per cent as illustrated in Figure 1. The recent decline of the CRB Index could be attributable to declines in the energy and industrial metals sectors, which accounts for 36 per cent and 14.5 per cent of the Index, respectively, while precious metals which experienced significant gains recently, accounts for only 7.5 per cent of the index.
The prices of key agricultural products such as corn and wheat were supported in 2011 by elevated levels of emerging market demand and adverse weather conditions in major agricultural exporters, such as Russia, Australia and Pakistan. Russia's decision to withdraw the country's export ban on wheat in May caused a temporary pull back in wheat prices. However, recent poor weather conditions in the major wheat exporting country, the United States, have raised concerns about possible shortages and further price increases. The other main agricultural commodity, corn, experienced a price increase of 16.44 per cent for 2011, due to supply shortages and increased demand in emerging markets, such as China. International grain prices are expected to remain elevated in 2011 owing to high levels of demand from emerging markets and adverse weather conditions, which will reduce crop yields.
Traditionally, food inflation has been the main driver of local headline inflation and the possible effects of price increases in these key agricultural products should be noted. The Central Bank of T&T recently indicated there was a two- to five-month lag in the transfer of global to domestic price changes. As such, the further spikes in wheat and corn prices may result in higher food prices during the year.
Energy sector
For the first half of 2011, political instability in the Middle East and North African regions and the possibility of oil shortages led to elevated oil prices. However, with the recent slowing of global economic activity, oil prices experienced a decline of 6.60 per cent year-to-date. Natural gas prices remained depressed owing to excess supply in the United States, with Henry Hub natural gas prices declining by 5.20 per cent during 2011. The outlook of energy prices are intricately linked to the global economic outlook. While many analysts have lowered their gross domestic product forecasts for 2011, they maintain that global economic activity will pick up in the second half of 2011. This growth is expected to be primarily driven by emerging markets and should result in higher oil prices. Analysts forecast oil prices to increase between the US$100 to US$105 a barrel range for the second half of 2011. However, if the current slowing of economic activity prevails, energy prices may remain depressed.
Additionally, the seizure of government control by Libyan rebels and the removal of Colonel Muammar Gaddafi may assist in stabilising oil prices. The resumption of oil production in Libya under the new rebel government should increase oil supplies and may contribute to lower oil prices.
Industrial metals
Similar to the energy sector, prices of industrial metals are linked to the economic cycle. Emerging markets, such as China, India and Brazil, have been leading the demand for industrial metals. With the recent slowdown in growth of these countries, the demand for these industrial metals decreased and the prices of industrial metals, such as copper, experienced a decline of 9.01 per cent year-to-date.
Precious metals
Precious metals emerged as the star performer among commodities for the year thus far. Gold prices in particular soared to unprecedented heights, with prices increasing by 23.91 per cent year-to-date amidst heightened risk aversion among investors. The price of gold rose to a historical high of US$1,897.6 per ounce in August. The "flight to quality" confirmed gold's status as a preferred safe-haven asset used by investors. Similarly, silver prices also increased significantly by 31.80 per cent year-to-date as investors sought the safety of precious metals.
The favourable performance of the precious metals sector stemmed from investors use of gold and silver to protect their capital from the uncertainty surrounding the fiscal woes of advanced economies.
Additionally, precious metals are used as an inflation and currency hedge to guard against rising prices and the decline of the US dollar. The increase in gold prices could also be attributable to the decline of the US dollar, which measured by the Dollar Spot Index, fell by 6.35 per cent year-to-date against the other main international currencies. Generally, precious metals prices are less volatile than other commodity and equity markets and the recent market turbulence may have spurred increased demand for precious metals.
Commodity exchange traded funds
Analysts recommend that a well diversified portfolio should contain some exposure to commodities and suggest an average portfolio allocation of 5.0 per cent. Over the long-term, commodities are negatively correlated to other markets and are used by investors to diversify their portfolio from traditional assets, such as stocks and bonds. However, the diversification benefits of commodities vary across commodity classes. For instance, gold traditionally is negatively correlated to the financial markets while oil is positively correlated to the economic cycle. Investors also use commodities as a hedge against inflation.
During times of accelerating inflation, the prices of commodities increase and protect the investor from the effects of inflation.
Exchange traded funds (ETFs) are the most convenient way for investors to add commodities to their portfolios. ETFs track the performance of commodities and are traded like stocks and subjected to price volatility. Investors can choose specific ETFs depending on their outlook for the respective commodity. For instance, if an investor expects the price of a commodity to fall, they can look at inverse ETFs (short ETFs) which benefit from declines of commodity prices. Similarly, if investors expect the price of a commodity to increase they can invest in a long ETF which will benefit from price increases. The current volatility of international financial markets may present opportunities for investors to purchase ETFs based on their outlook for a particular commodity. It should be noted ETFs are subjected to frequent price changes and are suitable to investors with higher risk appetites. While, commodity ETFs can provide investors with added diversification and enhance their portfolio returns, investors should only purchase ETFs after thorough research and consultation with a qualified investment professional.
Bourse Securities Ltd
askus@boursefinancial.com or
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