Commodities: Staying focused on the fundamentals

Despite recent market disruptions, a decline in global crude oil inventories could bode well for commodity investors

Commodities: Staying focused on the fundamentals
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2017 has been challenging for commodities, which are down more than 9% on the year as of May 5, 2017.1 In the first week of May, commodity markets experienced heightened volatility in the wake of rising US crude oil output and expectations of a recovery in Libyan production. Copper and iron ore prices have also retreated on renewed concerns about Chinese demand.

Supply is critical to energy commodities

However, commodity investors need to look at these developments opportunistically. In my view, investors are now presented with the best buying opportunity in energy commodities since before the production-cutting agreement last November among members of the Organization of the Petroleum Exporting Countries (OPEC). As I have often said, when it comes to crude oil prices, it’s all about supply. Global demand has shown a consistent trend for 25 years. But when sentiment is shaky, it doesn’t take much to squeeze wary investors from the market. And, true to form, some wary market participants have grown impatient with the delay in the drawdown of US crude oil inventories.

But this delay has been by design. OPEC’s stated goal has been to raise average crude oil prices globally, but to keep US inventories high for as long as possible. Doing so could limit production increases by US shale drillers — increases that could impede the price appreciation that OPEC member nations are working to accomplish in the global crude oil markets.

OPEC’s strategy has been effective to date, with US crude oil inventories higher than they were six months ago. But keep in mind that crude oil is a global market. My team forecast earlier this year that US crude oil reserves would begin to draw down in the second quarter of this year, and there is evidence that this is happening, as you can see in the chart below.

US crude oil inventories still high

US crude oil inventories

Source: Bloomberg L.P., as of May 5, 2017

Global crude oil inventories being drawn down at a rapid pace

In my view, the recent sell-off in crude oil is the result of investors taking their eye off the ball just as US inventories are starting to come down. It’s important to note that gyrations in the crude oil market over the past three years have been more about fluctuations in supply than shifts in demand. That has not changed.

Shale production has risen in the US at a faster rate than most expected, but OPEC’s production cuts, combined with ongoing supply disruptions in Libya, Nigeria and Venezuela, have pushed the global crude oil market into significant deficit, drawing down global inventories at a rapid pace. This is a promising sign for commodity investors.

US commodity investors need to think globally

Energy speculators have been highly focused on US crude oil reserves, and many lost patience while the markets rebalanced in Europe and Asia. A roughly 5% sell-off in West Texas Intermediate crude on May 4 had all the hallmarks of a capitulation in a market where sentiment has grown shaky.

But capitulations of this sort can create opportunity for savvy investors in markets where sentiment has disconnected from underlying fundamentals. For commodity investors focused on fundamentals, a cleansing of the palate could very well provide an appealing entry point.

Investors looking for a convenient and cost-effective way to invest in the commodity markets may wish to consider PowerShares’ lineup of commodity ETFs. PowerShares ETFs feature a rules-based, optimized yield strategy that seeks to optimize futures roll yield.

1 Source: Bloomberg L.P., as of May 5, 2017. Commodities represented by the DBIQ Optimum Yield Diversified Commodity Index.

Important information

Blog header image: Kodda/Shutterstock.com

Past performance is no guarantee of future results.

The DBIQ Optimum Yield Diversified Commodity Index is a rules-based index composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world. An investment cannot be made into an index.

Roll yield is generated by rolling a maturing futures contract to a later-dated futures contract.

West Texas Intermediate (WTI) is light, sweet crude oil commonly referred to as “oil” in the Western world.

Commodities, currencies and futures generally are volatile and are not suitable for all investors.

Investments focused in a particular industry or sector are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

Many commodity ETFs are not suitable for all investors due to the speculative nature of an investment based upon the ETF’s trading, which takes place in very volatile markets. Because an investment in futures contracts is volatile, such frequency in the movement in market prices of the underlying futures contracts could cause large losses.

Commodity ETFs are speculative and involve a high degree of risk. An investor may lose all or substantially all of an investment in these ETFs.

Many commodity ETFs are not mutual funds or any other type of investment company within the meaning of the Investment Company Act of 1940, as amended, and are not subject to regulation thereunder.

Jason Bloom
Global Market Strategist
PowerShares by Invesco

Jason Bloom is the Global Market Strategist representing the PowerShares family of exchange-traded funds (ETFs). In this role, Mr. Bloom is responsible for providing the overall macro market outlook across all asset classes globally, in addition to leading the team’s specialized efforts in commodity, currency, and alternatives research and strategy. He joined Invesco PowerShares in 2015.

Prior to joining PowerShares, Mr. Bloom served as an ETF strategist with Guggenheim Investments for six years and then River Oak ETF Solutions where he helped launch several funds focused on both energy and volatility related strategies. Previously, he spent eight years as a professional commodities trader specializing in arbitrage strategies in both the energy and US Treasury markets.

Mr. Bloom earned a BA degree in economics from Gustavus Adolphus College and a JD from the University of Iowa College of Law.

 

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