Topic Tags: Commodities

Can TIPS Be an Effective Inflation Hedge for Portfolios?

With the COVID vaccine’s worldwide distribution and adoption starting last week, many investors are aiming to project an inflation outlook driven by the return of furloughed workers and impending economic recovery and adjust portfolios with inflation protection in mind.

In this newsletter, we examine how key asset classes in institutional portfolios behave in rising or declining inflation environments, and ultimately determine the best asset classes that serve as inflation hedges while also providing strong total return and efficiency ratios. In particular, we investigate if TIPS (Treasury Inflation-Protected Securities) offer superior inflation protection compared to other common portfolio constituents.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Gold or Glitter?

Gold prices are hitting new highs, closing above the $2,000 per ounce threshold for the first time yesterday, August 4th. It is a familiar scene amid the confluence of economic concern and uncertainty brought on by the spread of COVID-19, negative real interest rates with 10-year Treasury yields just above 0.5%, a weaker U.S. dollar, and the potential for increased inflation following unprecedented monetary stimulus. But with an asset class that only makes headlines at extreme levels, it is important that investors know what they are really getting.

Over time, gold has produced real returns about in line with Treasury Bills (before any storage costs or impact from rolling futures contracts in contango), but with volatility that more closely resembles the S&P 500. And despite being widely considered to hold its value over time, gold is a physical asset whose price is determined by supply and demand, including ongoing mining operations and a large gold jewelry market in China and India. But what is perhaps most surprising is that gold is actually a poor inflation hedge. Over the last 50 years, the correlation between gold and core inflation has ranged from -0.55 to +0.75, with an average of 0.05.¹ Over time, equities have been the best option for outperforming inflation.¹ Dating back to World War II, gold has only outperformed equities in the short windows when inflation has been categorically greater than 6% (the last of which ended in 1982), and even then only half the time.¹ Thus despite the headlines that gold receives when its price is notably rising, it is not a particularly attractive allocation for long-term investment portfolios.

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¹ Goldman Sachs Investment Strategy Group

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

It’s Not Bad News for All Energy Stocks

With the steady stream of negative economic data, record-shattering unemployment figures, and ballooning government deficits, it has been hard to reconcile whether there is light at the end of the COVID-19 tunnel. This is coupled with the markets’ shrug-off of these gloomy figures, thus far, as we see daily green-shoots. The general expectation that we have a tough slog ahead until a vaccine is widely available has led some investors to “wait it out” on the sidelines.

This week’s chart brings attention to a flickering bright spot for investors, society, and the planet at large: the resiliency and relative outperformance of clean energy during this pandemic. The energy sector has been rocked by limited demand (due to the broad economic shutdown) and an oversupply of crude oil (caused by OPEC and Russia locking horns on price). And as shown, the global energy sector has careened downward, posting a YTD return of -37.1% through May 12th. However, if we include only those companies that embrace alternative energy, one can see that they not only have outperformed their oil-dependent peers but have also outpaced the broader market, posting -5.1% YTD return. These renewable energy and infrastructure producers are benefitting from increased demand, technological innovation, lower cost of capital, and potential expansion of tax credits (for wind and solar power), while not having their chief input dictated by oil price fluctuations.

While it would be irrational to believe that the world will unanimously cut oil consumption and usage immediately post pandemic, there are compelling arguments that our “new normal” will be more accepting of electric grid expansion and increased usage of renewable energy sources. In the U.S., we are likely still in the early innings of a multi-decade energy disruption, while developed countries within Europe and Canada are approaching the seventh inning stretch. The clean energy sector, which has been touted by the environmentally conscious crowd for years, is showing a level of resiliency that all investors should take note of.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Why Did the Price of Oil Turn Negative?

The price of oil as measured by the May WTI futures contract (gray line) fell to negative territory for the first time in history on Monday, plunging to -$40 before expiring at a positive price on Tuesday. Decreased demand for oil due to travel restrictions has caused an abnormal situation where in the short term, oil producers were willing to pay buyers to take their oil as they had limited storage space. Since physical delivery occurs on these future contracts, some were at risk of having purchased oil with no place to put it. However, when we look at the further dated June WTI futures contract (green line), the price change has not been as dramatic and remains in positive territory.

Demand has significantly weakened for oil, and supply cuts have been coming too late which are driving the price down. Price volatility is expected to be extremely high in the near term as gasoline and jet fuel are simply sitting in storage. Oil prices need to be around roughly $20 a barrel for United States domiciled companies to break even. Smaller energy companies with high debt burdens whose revenues are tied to the price of oil are unable to sustain low prices for long and are at risk of bankruptcy and laying off employees, further adding to the economic stress caused by the coronavirus. Such negative outcomes will also weigh on the equity and bond markets — as seen earlier this week — so the price of oil is clearly another economic variable that will be closely monitored through this pandemic.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

U.S. Petroleum Production Surges

U.S. crude oil production peaked in November 1970 at just over 10 million barrels per day. That record stood until this year, when U.S. production surpassed its previous high, and with OPEC’s recent decision to keep production constant, there are perhaps more opportunities for additional U.S. production to fill in the demand gap. As a matter of background, petroleum is the sum of crude oil (used for gasoline, jet fuel, diesel, and heavy applications such as asphalt and tar) and hydrocarbon liquids (most common examples are natural gas, propane, and butane).

Natural gas drilling has increased substantially since the passing of the Energy Policy Act (“EPAct”) of 2005 and has been a significant driver of the increase in petroleum production and exports. Furthermore, this legislation loosened regulation and put incentives in place to drive growth in crude oil and natural gas production in the United States, with the goals of reducing reliance on foreign sources and providing a buffer against high energy costs. This has driven 7.4% and 5.7% annualized growth of U.S. natural gas and crude oil production over the past 13 years, respectively. Historically crude oil production has driven overall petroleum output for the United States, but since the EPAct of 2005, natural gas has had a significant influence on the domestic energy markets. Natural gas’ share of the overall U.S. petroleum output has risen from 15.4% in January 1973 to 28.9% in June 2018.

Overall U.S. petroleum production has increased by roughly 8,000 barrels per day since the passing of the EPAct of 2005, resulting in a 519.6% increase in U.S. petroleum exports, and a 23.1% decrease in U.S. petroleum imports over the same period. With Brent Crude oil exceeding $80 per barrel in September, the active count of U.S. rigs is likely to increase as greater profit opportunities return to the petroleum market.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

And the Winner is… Commodities?

Through the end of May, 2018 has featured volatility and uncertainty across financial markets leading to some disappointing performance. Fixed income investments struggled as the yield curve rose with both core bonds and high yield slightly negative year to date. Broad U.S. equities are only up 2.5% after a rocky start to the year while international equities are negative following an exceptionally strong 2017. All this, along with fears about inflation, led to a surprising result: commodities are the best performing asset class in 2018. Despite this, the asset class is still by far the worst performer over both a 5 and 10-year period.

This week’s chart shows how difficult it is to time the market and why maintaining a consistently well-diversified portfolio is so important. The argument could be made that commodities were due to outperform (i.e. buy low and sell high) given their recent struggles. However, in 2014 commodities were down over 33%; investors hoping for a nice rebound the following year were in for a shock as commodities fell another 32.9% in 2015. On the flip side, last year emerging market (EM) equities was the top performing asset class, but those looking to chase this return now find themselves in the worst performing asset class YTD. There is little correlation between returns year to year and therefore we encourage clients to stick with long term allocations and avoid portfolio decisions based solely on recent returns.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

 

Value Underperformance in the Current Market Cycle

With the value premium seemingly in decline, value investors have had a lot to complain about over the past ten years. Growth stocks continue to soar despite rich valuations and increasingly lofty expectations. However, we are most likely closer to the end than the beginning of this “pro-growth” trend.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice nor an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Oil Market Disruption for 2018 is Closer to Home

Iran, one of the largest exporters of oil, rang in 2018 with a wave of political demonstrations across the country. Citizens gathered to protest Iran’s spiraling economic conditions, which include a 12% unemployment rate, high inflation, and elevated prices of basic goods such as eggs and dairy products. While energy analysts monitor such geopolitical events with due concern, the consensus is that the Iran riots have not caused a significant disruption of supply to the global oil market.

Instead, analysts are pointing to elevated oil production in the U.S., and the subsequent decline in imports. As depicted in this week’s Chart of the Week, net imports of oil to the U.S. dropped more than 65% in the past decade due to rising domestic production. Numerous U.S. shale drillers have pledged to expand exploration if crude oil prices hold above $60, driving imports down even further.

This rise in U.S. oil production has proved a headache for the Organization of Petroleum Exporting Countries (OPEC) and its affiliates, which have actively restrained output since 2016 in hopes of buoying prices. These cutbacks have successfully reduced oil inventories in these countries and the output restraint is set to remain in place through the end of this year. However, global supplies remain high and OPEC’s plan depends on continued compliance from its members. These factors coupled with U.S. production momentum could keep oil prices in check through 2018.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Fueling the Future: The Evolving Economics of Oil

Oil prices may have made headlines on Monday – closing above $50 a barrel for the first time since late May – but the economic outlook for fossil fuels remains uncertain. The International Energy Agency (IEA) reports that global energy investment fell by 12% in 2016, a second year of decline experts attribute to reduced spending on upstream oil and gas investments. Meanwhile, clean energy spending reached 43% of total global energy supply investment in 2016, a record high. While the IEA and large oil companies predict a greater than 10% rise in oil demand by 2040, a recent report by Bloomberg suggests that shifts in the energy economy could dampen such estimates.

This week’s Chart of the Week illustrates the hypothetical effects of technological advances, electric cars, and alternative energy sources on the IEA and oil industry’s demand predictions. Transportation – which alone accounts for about 60% of oil use – has enjoyed technological advances which have led to increasingly efficient engines, less fuel waste, and shorter trips due to better navigation systems. Concurrently, Bloomberg predicts more than 20 million sales of electric cars by 2030 due to shifting consumer preferences and aggressive policies in China, India, and Europe. Lastly, alternative energy sources such as biofuels and natural gas could supplant oil demand as clean energy investments continue to gain traction and popularity. These variables combined could drastically impact the economics of oil over the next several decades.

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U.S. Domestic Barrel Bulge

This week’s chart chronicles monthly U.S. oil production sourced from the seven major land production zones from January 2011 to April 2017. The price of oil experienced volatility over recent years resulting from macroeconomic factors like OPEC’s pump-at-will strategy and the subsequent supply glut that forced U.S. producers to reduce output. However, following OPEC’s production cut agreement in late 2016, U.S. oil production is on the rise, supported by rig productivity gains in both new and legacy wells as well as reduced capital costs. Gains from legacy wells have been particularly significant in the Eagle Ford and Bakken Regions since 2012, while in the Permian region an almost fourfold increase in new rigs from 2015 to 2017 helped solidify the area as the dominant production region. Overall, net imports of petroleum products as a share of consumption dropped from about 49% in 2010 to about 25% in 2015, showing progress towards a more energy independent U.S.

OPEC’s production cuts and a lower global supply signal positive news for U.S. producers. Khalid Al-Falih, the newly appointed Oil Minister of Saudi Arabia, committed to lengthening the OPEC supply cut on May 7th. “I am rather confident the agreement will be extended into the second half of the year and possibly beyond,” said Al-Falih. Lower breakeven costs and reduced supply from OPEC nations could incentivize U.S. producers to further ramp up production going forward.

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