As the curtains come down on the third quarter of 2012, we review this week the performance of the commodities market for the year thus far. With an unresolved general feeling of uncertainty prominent throughout the world, monetary authorities including the European Central Bank (ECB), the US Federal Reserve (Fed) and the Bank of England have employed bond buying programs in order to spur their economies and stimulate growth.
The Thomson Reuters CRB Index, which tracks the performance of a basket of commodities, as illustrated in Figure 1, shows the general trend in the commodity market since the beginning of the year.
During the third quarter of 2012, commodity prices followed a positive price trajectory. As at the end of the quarter, the index is up 2.87 per cent year to date. This is largely attributed to stronger macroeconomic data arising from the United States on account of their third round of bond buying which boosted investor confidence. Additionally, the ECB launched an unlimited bond buying program to aid struggling euro area nations.
Sectoral review and outlook
Grains sector
Globally corn, soybean and wheat supplies have tightened as a result of the unexpected drought that plagued the US Midwest in July. This was the worst drought that the US, the world's largest corn exporter, has experienced in over 50 years.
Similarly, in Australia, the second largest wheat exporter, dry weather affected wheat reserves causing it to deplete by approximately 14 per cent year to date as at the end of September. As a result, grain prices tested record highs throughout the third quarter. Reports show that corn and wheat prices have risen by 19.68 per cent and 42.79 per cent year on year respectively.
Most analysts forecast higher wheat, corn and soybean prices for the rest of the year, given the low level of crop inventories.
Energy sector
Crude oil prices are currently primarily driven by prevailing global macroeconomic conditions and investor sentiments rather than market fundamentals. As such, the crude oil market has been more volatile than the natural gas market. Events such as, the fall in oil demand by China placed downward pressure on the price, whereas the political factors in the countries of Sudan, Yemen and Syria which contributed to stagnant growth in oil production placed upward pressure on the commodity.
Thus far for 2012, crude oil prices ranged between US$77.69 per barrel and US$109.49 per barrel, with an average price of US$95.80 per barrel. For the third quarter, oil prices generally increased; however it plunged towards the close of the quarter. Consequently, year-to-date, WTI crude oil prices fell by approximately 10.52 per cent.
According to the Energy Information Administration (EIA), average WTI crude oil prices are expected to be recorded at US$95.55 per barrel in 2012 and US$92.63 per barrel in 2013.
On the gas front, prices ranged from a low of US$1.84 per MMBtu before a significant recovery brought prices up to a high of US$3.38 per MMBtu.
Unlike oil, records show that year-to-date, Henry Hub spot price for gas increased by 10.8 per cent. See Figure 2. Gas prices increased during the third quarter, as the largest refineries in Canada and Europe underwent maintenance, reducing supply. The EIA projects the Henry Hub natural gas price will average US$2.71 per MMBtu in 2012 and US$3.35 per MMBtu in 2013.
Precious metals
When the Fed released the news of committing to a third round of quantitative easing to spur the economy, gold rose to its highest level in almost seven months of US$1770 an ounce.
Gold has risen for 11 consecutive years, reaching a record high of US$1,923.70 an ounce in July 2011 before closing at US$1566.80 an ounce at the year's end. Year-to-date, gold prices increased significantly 11.87 per cent to US$1737.97 an ounce. Analysts expect gold prices to strengthen further, projecting a one-year futures price of US$1767.20 an ounce.
Industrial metals
Like crude oil price, prices of industrial metals are intricately linked to the economic cycle. Emerging markets such as China, India and Brazil have been leading the demand for industrial metals, for example, copper. Industrial metals returns had been low in the first seven months of the year.
However, it received a strong boost at the end of August in anticipation of the Fed's bond buying programme.
In an environment where growth in the emerging markets in particular China, is waning, it is expected that the rally in industrial metal may be difficult to sustain.
Adding commodities to your portfolio
A well-diversified portfolio should contain some exposure to commodities and suggest an average portfolio allocation of around five per cent. 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 thus allowing the investor to benefit from the price changes. As we noted previously, gold is one of the commodities used by most investors as it has proven to sustain positive returns for the past eight months and is forecasted by most analyst to maintain this positive trend in 2013.
Commodity ETFs
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, increase in value 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 adviser. Local investors can gain exposure to commodities and can acquire ETFs from several licensed investment firms such as Bourse.
