Commodities have rallied broadly thus far this year with energy leading the way resulting in a 6.34% gain for the RICI® versus the 4.64% gain in the benchmark Bloomberg Commodity Index (“BCOM”) as of 2/8/19. All three sectors are positive with 31 of the 38 components showing gains YTD. We believe the correction that began in the second half of 2018 ended in late December as oil prices bottomed after nearly a 40% decline in price during the fourth quarter. The rise in prices across most of the commodity complex in early 2019 may be indicative of a positive year ahead.
Calendar 2018 In Review- A Tale of Two Halves:
For the first two quarters of 2018, the RICI® achieved solid positive performance which was a continuation of the upward trend in prices that occurred in the last two quarters of 2017. In addition, it provided excellent diversification during the heightened volatility across global equity markets and finished the first half of 2018 as one of the best performing asset classes (2nd Quarter Commentary). However, the second half of the year was a different story. In the 3rd quarter oil prices continued to rise while the agriculture and metals sectors were particularly weak due to the growing fears of an escalating trade war and mounting tariffs. The RICI® ended down slightly (-1.6%) representing the first quarterly drop since the June 2017 (3rd Quarter Commentary). The 4th quarter was greeted with an unexpected deep drop in oil prices of nearly 40% coupled with a return to heightened volatility and declines across global equity markets. Although metals and agriculture continued to show little correlation to the equity market turmoil and were close to unchanged, the RICI® declined -12.97% for the quarter, slightly less than the decline in US and International Equities. After significantly outperforming the benchmark BCOM in the first 3 quarters, the RICI® lagged BCOM in the quarter due primarily to its higher oil weighting. The drop in crude oil and refined product prices was caused by an unusual confluence of events: global trade worries brought on by sanctions and tariffs; reduced growth expectations for China; a renewed recessionary outlook for Europe; uncertainty around both crude oil supply (OPEC actions, Saudi geopolitical concerns, Iran export sanctions); and near record long holdings by speculators. After advancing to a high of +24.21% through the end of September, the drop in the 4th quarter left the RICI® Energy Index down -12.01% for the year.
Oil in Perspective:
Although the RICI® currently contains 38 commodities, energy often gets heightened attention due to its importance in the functioning of world economies and the level of volatility it has exhibited over time. After making a major bottom in early 2016, oil prices began to recover and went on to have a strong rise into year end. Then, in early 2017, energy experienced a sharp pullback amidst heightened investor pessimism only to re-establish its positive trend through the balance of 2017 and well into 2018. Our opinion of the price action exhibited in the 4th quarter of 2018 was that it represented another major opportunity as it was an extreme but limited overreaction to a series of unknowns that, once even partially resolved, would result in stabilization of the energy markets as fundamentals would prevail (see our December Commentary).
The RICI® outperformed the BCOM for the third year in a row despite having a much higher weighting in oil. As a reminder, our methodology calls for us to add to positions that have declined in price, rebalancing back to index weights on a monthly basis. This discipline once again demonstrated its value in a volatile year. Although we may have seen a pause in Fed tightening policy, higher interest rates are positive for commodity index performance expectations. As rates increased throughout 2018, the contribution to total return based on the 90 day T-bill became more meaningful. Rate increases are also historically a policy response to higher expected inflation, which is, of course, generally positive for commodity prices. As in previous commentaries, we call attention to the fact that commodity recoveries, once underway, are typically multi-year in duration, and that the recovery in commodity prices that began in early 2016 is in the very early stages (Significant Recovery Potential). The case for commodities in diversified portfolios remains solidly intact and the consumption-based RICI® methodology represents one of the best and most diversified ways of investing in the overall asset class.
A Global Demand-Based Portfolio
The RICI® is a composite, US dollar-based, total return index methodology. It represents the value of a basket of commodities consumed in the global economy, ranging from Agricultural to Energy and Metal products. The Index’s weights attempt to balance consumption patterns worldwide (in developed and developing countries) and specific contract liquidity. The value of this basket is tracked via futures contracts on 38 different exchange-traded physical commodities, quoted in four different currencies, listed on nine exchanges in four countries.
DISCLAIMER: The index returns shown above do not represent the results of actual trading of investible products, assets or securities. It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available only through investable instruments based on that index and there can be no assurance that investment products based on the index will provide returns that are similar to the actual index performance or provide positive investment returns. All the indices referred to in this presentation above are not investable products and their returns do not reflect the fees and charges inherent in investing in a vehicle designed to replicate a particular index. Any index performance provided is for illustrative purposes only. The time period selected represents the inception date of the Rogers International Commodity Index® and is intended to provide a historical long-term average. Data provided by Bloomberg LP, BarclayMAP, and RBC Wealth Management. Past performance is not indicative of future performance.