In the Aftermath of Brexit

We believe that the positive turn in commodities this year could be the start of a multi-year reversion to the mean. The rally this year from the January/February lows has been very broad and has similar characteristics to rallies from other bear market lows.

The increase in prices is being driven primarily by the reduction of supply/production across the energy and mining industries. It is not a growth in demand story. We do not need strengthening GDP growth when supplies are being drastically cut. As evidence we can look to the 1997-1998 bear market ended in March of 1999 and the RICI® went on a mutli-year recovery. From 12/31/1998 – 12/31/2002 the RICI® appreciated over 90% while the US GDP growth went from over 4% to under 2%.

The uncertainty of the effects of Brexit simply reinforces the decisions by mining and energy companies to cut exploration, close mines and reduce capital expenditures. In fact it may accelerate this trend due to uncertainty of economic conditions created by Brexit.

The short term volatility in prices has the same effect.

Slowness in the UK economy is not a major factor as the UK only consumes about 1/16th of the oil that the US does so any economic slowdown is not significant in respect to energy, our largest sector. In addition, agriculture prices should have no effect from Brexit and is 35% of our portfolio..

The US Dollar rallied strongly on news of the Brexit. All other things equal, a strong dollar is usually negative for many commodity prices but not the main determinate. In 1999, and 2000 commodities as measured by the BCOM were up 24% and 31% despite the dollar being up 8.1% and 7.5% those same years! So investors should not be making their commodity decision based on the US dollar particularly at this stage in the cycle after the dollar has already been up for 4 years!

The short term reaction for commodities to decline on the news is not surprising investors/traders move to lower risk. However, commodities have held up much better than equities since the Brexit and has outperformed on both the negative days and yesterday the recovery day. It is helping the portfolio.

Tuesday RICI® up 1.92% S&P 500 UP 1.79%     . -13% better

Monday RICI® down .87% S&P 500 down 1.8%  – .93% better

Friday     RICI® down 2.1% and S&P 500 down 3.6%  – 1.5% better

Conclusion: any sell off in commodities in the short term related to fears of Brexit or dollar strength should be considered as an opportunity.

Alan Konn
Managing Director

Alan Konn

Partner & Managing Director of Price Asset Management

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