Commodity prices ended the second quarter down slightly with the RICI® Methodology down -1.27%, on par with the benchmark BCOM which was down -1.19%. It was a volatile quarter amongst the sectors with many crosscurrents. Energy was up +5.26% in April as Oil continued to recover from the 4th quarter, 2018 decline. Energy reversed sharply, declining -13.02% in May as fears that the continued trade dispute might lead to a broad economic slowdown resulting in a decline in Oil demand. The sector snapped back +5.49% in June due to growing concerns regarding Oil shipping security in the Middle East, escalating tensions with Iran and evidence of continued capital market pressure on the fracking industry constituents. Metals, on the other hand, sold off in both April and May, down -2.25% and -3.87% respectively as the concerns over the global economy led to generally weaker Industrial Metal prices. June saw Metals recover some of the decline with a sharp +4.22% increase led by large double digit increases in Nickel and Palladium prices due to continued tightness in supply. Also contributing was the approximate +8% rise in Gold which appeared to be reacting to the heightened geopolitical risks. Agriculture was weak in April, continuing the weakness that began in February. Ample Wheat supplies in the US coupled with strong production in Europe and Russia continued to pressure prices while the ongoing trade dispute and the growing issues with the African swine flu continued to depress Soybean prices. May was a different story as record droughts throughout the Midwest caused prices amongst the major grains to begin a sharp move from their mid-month lows leaving Agriculture up +4.11% for the month of May. Prices then flattened in June as participants waited to see what the long-term impact will be on supplies and prices.
Crosscurrents for Commodities
Fracking in the US has begun to show its limitations and the US growth in production is expected to slow in 2020. The key question is how will this affect the global balance of demand and supply as traditional sources of Oil remain under pressure from the massive capital expenditure cuts over the past several years. Although global demand in Energy may finally slow if the growth in global economies declines; will central banks be able to “save the day” with monetary and/or fiscal stimulus? In addition, the developments in the Middle East may lead to disruptions in supply and possible sudden price spikes regardless of the state of the economy.
Natural Gas prices are at a multi-year lows; however, global demand for this cleaner energy source continues to grow. Low prices should lead to an acceleration in its growth and today’s prices may look incredibly cheap when we look back at this volatile commodity.
Tightness in industrial Metal markets are beginning to appear as significant marginal production in numerous metals were closed as a result of the 2011-2015 bear market. Historically, prices have appreciated significantly when supplies are constrained even when demand growth is slowing. This year, Nickel and Palladium are two examples of Metals that have recently experienced strong price increases as a result of tight supplies. With demand expected to outpace supply in both 2019 and 2020, is Copper next?
Precious Metals finally appear to be reacting to the growing geopolitical turmoil in the Mideast and elsewhere. Will their “safe haven” status finally return and prices break out over the months ahead?
Many Agricultural commodity prices are at multi year lows and the sector has underperformed the other sectors since the inception of the RICI® in 1998. In the near term, after numerous years of above average US crop production, the historical flooding and adverse conditions across much of the Midwest may finally lead to below average crops and a sustained rally in prices; however, it is still too early to predict. It is interesting to note that there have been 3 sustained rallies in Agriculture over the past 20 years with each one beginning from a bottom in prices made in the second calendar quarter.
Agriculture Sector Rallies:
June 2002 – April 2004: Total Return of 33%
April 2006 – June 2008: Total Return of 49%
May 2010 – August 2011: Total Return of 57%
The longer-term picture for Agriculture is positive as demand continues to grow worldwide led by the changing consumption patterns occurring as China and India industrialize. One major bank predicts the next super cycle in commodities will begin in 2020 led by Agriculture as China’s demand for food launches a new multi-year commodity super cycle.
The Long Term Opportunity
The commodity asset class remains out of favor and we believe underweighted in institutional portfolios. This is not surprising given the bear market of 2011-2015, In addition, the recovery from what we believe to be a secular low in early 2016 has been uncharacteristically muted thus far while financial assets have appreciated considerably. However, reversion to the mean can be a powerful force in portfolio management and at the present time, investors have the opportunity to add this asset class while prices are deeply depressed both on an absolute basis and relative to financial assets. (Significant Recovery Potential)
A Global Demand-Based Portfolo
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.