If a Six Flags Magic Mountain trip over the summer did not fulfill one’s adrenalin requirements, consider a career in trading Commodities this Fall! As the days go by, one’s yearly subscriptions would gravitate towards a permanent subscription for anti acid and heart burn medication. Commodity markets have been a in a bear market for last three years, but judging by the violent moves of the last month alone, a lot of three letter acronyms other than OMG come to mind. On the one hand, one can be quite spiritual about the whole thing, take the enlightened road and decide to do nothing. In 2008, this would have been the perfect strategy. But alas, we are but mere mortal Portfolio Managers.
After Commodity stocks fell 30% in the last few weeks of September to then rally 50% in some cases in the first week of October alone, the question doing the rounds across boardrooms globally is, “Is it time to buy Commodity stocks?”
Emotions aside, let’s get cerebral. Since the start of the year, it was unanimously believed that the Fed would raise US interest rates sometime this year. Post Chinese devaluation volatility at the end of August and concerns of soft economic data filtering into Developed Markets, the Fed decided to hold off an immediate hike despite robust US data. BOOM! That was the cue to unwind everything. Investors sold the dollar and along with it bought Bonds, Emerging Market Currencies and Indices. But if the Fed held off because it was worried about global growth, does it not seem a tad bit perverse to buy risky assets and cyclicals?
Everyone is fixated on the dollar trade for now. Covering shorts is not the same thing as going long. In September allocation in Global Commodities was at a net 28% underweight and long dollar was the most consensual position. Any pebbles thrown in that stream of thought, would cause a ripple effect throughout.
So has the Oil price found a floor? If I had a penny for each time “China” was blamed for either markets going up or down, I would not need to be a portfolio manager. Chinese GDP has been contracting, but it has been consistently soft in a range of 5-7% for last few years, yet Commodity prices have kept keep falling. There are so many more moving parts than just China. What investors fail to understand is that a Commodity is a resource, either one has it or not. If it’s the former, then no matter what the demand is, it is supply that dictates its price. That is the dilemma we face today. There is just too much supply in most Commodities ranging from Oil to Copper to Iron ore. As prices go down, companies enjoy a lower cost of production from lower input costs, delaying production cuts leading to yet even lower prices. This adjustment process will continue until excess supply is cleaned up.
Brent Oil trading at $50/bbl may not be a buy just yet. Looking at the EIA data, US stock builds are still larger than the seasonal norm for crude and the main products, in particular gasoline. It is misleading to look at the US rig count alone, US companies have idled rigs but actual production has not come off sustainably. They are smarter and more efficient. It is survival of the fittest and whoever takes the most market share survives. OPEC crude supply rose by 90,000 b/d in September to 31.7m b/d led by record Iraqi output which offset declines from Saudi Arabia. Year to date the group has pumped 31.2m b/d, 1m b/d higher than the same period a year ago. Even Russia and Brazil reported production to new record highs in September.
Portfolio Managers have become “macro headline trading junkies”. Correlation across all asset classes is one. There is no evidence of stock or sector selection as we are all chasing the same trade. It’s not science, it really is that simple. Volatility is elevated on the back of bipolar investor mindsets. Regardless of Fed delaying hikes or not, the fact of the matter is that Commodity markets are plagued with excess supply.
