Bourse Securities Ltd
As the second quarter draws to an end, this week we review the performance of commodities for 2012 so far. While commodities have traditionally been negatively correlated to stocks in that their prices move in opposite directions, in recent years the trend have reversed with the prices of key commodities, such as energy, metals and precious metals moving in sync with stock prices. During the first half of 2012, as investor optimism dissipated and stock markets began to experience volatility and downward pressures, commodity prices mirrored this trend and began to experience price swings. The Thomson Reuters CRB Index, which tracks the performance of a basket of commodities, reflects the general trend in commodities markets over the past six month. As Figure 1 illustrates, during the 1Q 2012, commodity prices followed a positive price trajectory, as stronger macroeconomic data arising from the United States boosted investor confidence. However, as the European debt crisis intensified during 2Q with Spain requiring financial aid from the European Union, investor confidence plummeted. Consequently, as financial markets reacted to the developments in the Euro area, commodity prices were placed under downward pressure, with the Thomson Reuters CRB Index experiencing a decline of 0.98 per cent year to date.
Sectoral review and outlook
The deteriorating macroeconomic outlook for the major global economies weighed on agricultural commodity prices during the 1H 2012. However, wheat prices were supported by lower than expected global inventories and adverse weather conditions in some of the major wheat producing countries including the United States and Russia. As such, wheat prices experienced a 1.76 per cent price increase for the year so far. On the other hand, corn prices which declined by 2.66 per cent during the 1H 2012, are expected to remain flat amidst supportive weather conditions which are expected to boost inventories.
Crude oil prices are traditionally more susceptible to changes in the economic cycle and market sentiment. As such, while crude oil prices were supported during the first quarter by signs of recovery in the global economy, the slowing of economic activity during the second quarter adversely affected prices. During the second quarter, crude oil prices plunged as concerns over Europe and the global weakening macroeconomic environment eroded investor confidence. Year-to-date, WTI crude oil prices fell by 14.98 per cent. The fall in price is largely attributable to the fundamentals of demand and supply. The world has been producing more oil than it’s consuming. In fact, global oil consumption has been declining since the end of 2011, falling to 88.5 million barrels per day at the end of April, from 90.4 million barrels per day in late December 2011. At the same time, world oil production has been rising steadily, driven by new finds and drilling techniques in North America and increase in production from OPEC during the past 12 months. However, geopolitical tensions between Iran and the West are expected to place upward pressure on crude oil prices in the upcoming months. In fact, the major international houses expect WTI crude oil prices to cross the US$100 per barrel landmark by the end of 2012. Similarly, to crude oil, Henry Hub natural gas spot prices followed a downward trajectory and declined by 12.75 per cent for 2012 so far. The fall in natural gas prices can be attributable to the excess supply conditions and significant increases in inventories which have continued to place downward pressure on the commodity.
Unlike its outstanding performance in 2011, where gold prices recorded a 10.52 per cent increase, during the first half of 2012 gold prices remained relatively stable. Year-to-date, gold prices increased modestly 2.67 per cent. However, subdued economic growth in the US and tepid economic activity in the global economy is expected to support gold prices for the second half of 2012.
Like crude oil price, the prices of industrial metals are intricately linked to the economic cycle. With concerns over the slowing of key emerging nations such as China, India and Brazil, and the anaemic recovery in the United States and Europe, industrial metals prices were placed under pressure during the second quarter of 2012.
For instance, copper prices declined by 0.68 per cent year-to-date. The outlook for industrial metals remains dependent on the performance of the global economy and in particular, any increase in demand from China, the main importer of industrial metals.
Adding commodities to one’s portfolio
The major international houses recommend that a well-diversified portfolio should contain some exposure to commodities and suggest an average portfolio allocation of around five per cent. Over the long-term, commodities 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, thereby allowing the investor to benefit from the price changes.
Exchange Traded Funds (ETFs) are the most convenient and cost effective way for investors to gain direct exposure to commodities and add value to their portfolios. ETFs track the performance of commodities by attempting to mirror the performance of a specific index or commodity. They are traded like stocks and thus are subject to price volatility. It should be noted ETFs are subjected to frequent price changes and are suitable to investors with higher risk appetites. Also, at times ETF prices may diverge from the price of its underlying index or commodity. Investors can choose specific directional 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, as the name implies, gains when commodity prices fall and vice versa.
Similarly, if investors expect the price of a commodity to increase, they can invest in a long ETF which will benefit from price increases. In volatile times such as this, the risk tolerant investor can seek to make short-term plays and take advantage of temporary price swings in commodity prices. However, this trade play is only suitable to investors with high-risk appetites and investors should only purchase ETFs after thorough research and consultation with a qualified investment advisor.
Local investors can gain exposure to commodities and can acquire ETFs from several licensed investment firms within the local financial sector, such as Bourse.