Topic Tags: Commodities

Has Oil Been Oversold?

Between June 2014 and the end of January 2015, oil experienced a precipitous fall from $107 per barrel to $45 as reduced demand and excessive supply combined to drive its price significantly lower. During that time, the Credit Suisse High Yield benchmark experienced a -3% total return, as 15% of the index is comprised of energy issuers. In February, oil recovered to $52 and the high yield benchmark rebounded by 3%. Given the wide dispersion of projected oil prices, we attempt to gauge how fairly priced both oil and high yield energy bonds currently are, based on the Baker Hughes North America Rotary Rig Count.

Between June 2014 and the end of January 2015, oil experienced a precipitous fall from $1071 per barrel to $45 as reduced demand and excessive supply combined to drive its price significantly lower. During that time, the Credit Suisse High Yield benchmark experienced a -3% total return, as 15% of the index is comprised of energy issuers. In February, oil recovered to $52 and the high yield benchmark rebounded by 3%. Given the wide dispersion of projected oil prices, we attempt to gauge how fairly priced both oil and high yield energy bonds currently are, based on the Baker Hughes North America Rotary Rig Count.

The Baker Hughes North America Rotary Rig Count is an important business barometer for the oil and gas industry because it tracks active oil drilling rigs and serves as a leading indicator for the demand for oil and gas products and services. The rig count nosedived from 1,931 at the end of September 2014 to 1,267 at the end of February 2015, a period of just five months.

This week’s chart divides the price of oil by the rig count. By doing this, we can see how overpriced or underpriced oil is in the context of active rigs. The blue line shows that oil was generally overpriced over the last six years and is now somewhat cheaply priced as it falls below its average shown by the dotted blue line; the significant reduction in rig count has helped to improve this ratio. The green line shows the spread of energy bonds in the Credit Suisse High Yield benchmark divided by the same rig count. It currently sits above its average, suggesting that perhaps energy high yield bonds have been oversold, and may offer a buying opportunity for value-driven investors.

1As measured by West Texas Intermediate crude, the benchmark for oil prices in the United States.

2015 Market Preview

January 2015

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2015 is no different: U.S. equities are at all-time highs, uncertainty reigns for international equities, and to everyone’s surprise, interest rates fell dramatically in 2014…but are poised to rise from historic lows over the next year. In the alternative space, real estate remains a solid contributor to portfolio returns, and private equity delivered on return expectations, though dry powder is on the rise. Hedge fund results were mixed, but have shown to add value in past rising interest rate environments. Further macroeconomic items that bear watching for their potential impact on capital markets include the precipitous fall in oil prices, the strengthening U.S. dollar, job growth, and international conflicts.

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Economic Impact of Falling Oil Prices

The economic impact of falling oil prices has been a common discussion point for investors over the past few months. Who benefits? Who doesn’t? In this week’s Chart of the Week, we look at what different oil prices mean to various parties.

The economic impact of falling oil prices has been a common discussion point for investors over the past few months. Who benefits? Who doesn’t? In this week’s Chart of the Week, we look at what different oil prices mean to various parties.

Oil prices fell by more than 40% in 2014 as a result of strong production and OPEC’s refusal to support prices. Brent crude, the international benchmark for oil, began the year at $110, which is significantly less than the level necessary for certain countries like Venezuela and Iran to balance their budgets. Earlier this week, Brent crude fell to less than $47. According to the Financial Times, an oil price of $90 is necessary for Saudi Arabia to balance its budget, while Kuwait would be happy with levels above $50. In the U.S., the outlook for operators of shale oil developments will be heavily dependent on their cost structures — an oil price of $115 is needed for high-cost producers to break even, but low-cost producers can break even with prices as low as $40. A major beneficiary of the slippery slope in oil prices is the airline industry. With oil at the level of $95, they would see a boost to 2015 operating profits of approximately $15 billion.

The takeaway is that the economic impact of the slide in oil prices is not the same for all market participants. As such, this environment presents interesting tactical opportunities for domestic and international investors with exposures to governments and corporations.

Lower Oil Prices a Tailwind for Airline Stocks

Our chart of the week examines how the fall in the price of oil – despite its recent impact on the overall stock market – has benefitted the airline industry and should continue to do so in the near future.

Our chart of the week examines how the fall in the price of oil – despite its recent impact on the overall stock market – has benefitted the airline industry and should continue to do so in the near future.

The chart shows how oil prices have steadily declined since June to roughly $56/barrel as of December 16th. Over the same period, U.S. equities — as represented by the S&P 500 — have marched higher, led by stronger than expected earnings and an increasingly favorable jobs market. Given the drop in oil prices, it may not be entirely surprising that airline stocks as a group have been one of the strongest performers in 2014, gaining 34% so far this year. Since one of the largest expenses for any airline is fuel, the recent decline in prices coupled with both the large volume of travelers in the fourth quarter and rise in airline ticket prices should translate to one of the most profitable quarters for a sector already flying high. The nosedive in oil prices may not be the best news for the overall market (seen at the very end of the graph) but should bode well for airlines and the managers who choose to invest in this soaring sector.

Real Assets: The State of Commodities

December 2014 Investment Perspectives

Commodity market investors received a ray of hope in the early months of 2014. After several years of consecutive declines, commodities, as measured by the Bloomberg Commodity Index, began the year on strong footing and posted a gain of 7.1% in the first half of the year. By the end of the third quarter, however, commodities entered negative territory, and the year-to-date return through November for the Bloomberg Commodity Index had fallen to -10.2% (Exhibit 1). In this newsletter, we examine the recent developments in the commodity markets and evaluate their prospects for the coming quarters.

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Impact of Low Oil Prices on Emerging Market Investments

Many investors are concerned that the recent decline in oil prices will pose significant headwinds for investments in emerging markets debt and equity, since many emerging countries are known as significant exporters of oil. In the same vein, the economic slowdown in Europe and China may translate to reduced consumption of emerging countries’ commodity exports. Our Chart of the Week examines the impact of lower oil prices on the potential returns for emerging market investments, specifically debt and equity.

Many investors are concerned that the recent decline in oil prices will pose significant headwinds for investments in emerging markets debt and equity since many emerging countries are known as significant exporters of oil. In the same vein, the economic slowdown in Europe and China may translate to reduced consumption of emerging countries’ commodity exports. Our Chart of the Week examines the impact of lower oil prices on the potential returns for emerging market investments, specifically debt and equity.

While all emerging market countries are exporters in one way or another, they do not all primarily export energy or even commodities. As shown in the bottom right of this week’s chart, Venezuela and Nigeria rely heavily on energy exports and the recent drop in oil prices has been a negative trend for their sovereign and corporate debt as well as the stocks of companies in those countries. In the top right, there are more emerging countries that rely on commodity exports that are non-energy — countries that rely more on mineral and agricultural exports, such as Chile and Brazil. Finally, in the top left, there are even more emerging countries that have much more of their exports in the form of non-energy, non-commodity goods, such as Israel and China, which export mainly manufactured goods. In some cases, the fall in commodity prices is beneficial for commodity importers like India and Turkey.

Based on the chart, there does not appear to be an overreliance on oil – or commodity – exports to support the collective economies of emerging market countries. While some countries will most certainly feel the direct impact of lower oil prices, emerging market investments should not be disproportionately hurt by falling oil prices.

Improving Diversification Profile for Commodities?

As they are driven more by supply and demand and less by macroeconomic factors, commodities have historically enjoyed low correlations to other asset classes in an investment portfolio, and are often utilized as a source of diversification. However, the correlations between commodities and other asset classes, such as equities, fixed income, and hedge funds tend to be fluid over time and can change significantly over a market cycle.

As they are driven more by supply and demand and less by macroeconomic factors, commodities have historically enjoyed low correlations to other asset classes in an investment portfolio, and are often utilized as a source of diversification. However, the correlations between commodities and other asset classes, such as equities, fixed income, and hedge funds tend to be fluid over time and can change significantly over a market cycle. Our Chart of the Week examines the recent movement in correlations between commodities and the most common constituents of an institutional portfolio: U.S. equities, international equities, bonds, and hedge funds.

The chart above illustrates that in the years leading up to the summer of 2007, rolling 5-year correlations between commodities and other asset classes ranged from as low as -0.07 for fixed income to as high as 0.36 for hedge funds. Correlations spiked after the collapse of Lehman Brothers in September 2008, as macroeconomic conditions took the driver’s seat and pushed correlations to equities and hedge fund strategies upwards over the following years. Recently, though, these correlations have started to retreat towards pre-recession levels, with correlations generally decreasing since July 2013. Given this downward trend, the correlations between commodities and other asset classes make a better case for the asset class and its diversification benefits now than it did a few years ago.

Commodities Start Positively in 2014

This week’s Chart of the Week examines how the commodities markets have fared since the start of the year. After three years of negative returns driven by relative unattractiveness to equities and fixed income, coupled with declining inflation, commodities began 2014 on a strong foot.

This week’s Chart of the Week examines how the commodities markets have fared since the start of the year. After three years of negative returns driven by relative unattractiveness to equities and fixed income, coupled with declining inflation, commodities began 2014 on a strong foot.

Commodities, as measured by the Dow Jones UBS Total Return Commodity Index, enjoyed four months of consecutive gains and, despite May’s pullback, have advanced by 6.4% so far this year. The strongest growth came from the livestock complex, as the DJ UBS Livestock sub-index benefited from improving supply fundamentals and climbed 12.2% in the first five months of the year. Agriculture has also been strong this year with a gain of 11.9%.

Industrial metals have been the weakest area in 2014. The DJ UBS Industrial Metals sub-index increased by only a modest 0.9% through the end of May. China’s economy, no doubt, has had a negative impact on base metals — concerns over slowing growth in the Chinese economy have weighed on the industrial metals complex. Precious metals have fared slightly better this year with a gain of 1.6%.

Although commodities in aggregate remain below their 2010 levels, their upward momentum thus far provides a positive outlook for investors with commodities exposure.

Emerging Trends in Alternative Asset Classes

2013 Marquette Investment Symposium session

In this presentation from our 2013 Investment Symposium, we explore various emerging trends in the alternatives space, including low volatility equity, tail risk, managed futures, gold, MLPs, GTAA, risk parity, farmland, direct lending, and opportunistic credit.

Investment Symposium 2013
Recorded September 13, 2013

Please contact us for access to this video.

Rising Gold Prices Fail to Benefit Gold Mining Companies

This week’s Chart of the Week compares gold prices to the MSCI ACWI Select Gold Miners Index. Typically, most investors would expect gold mining company returns to closely track those of gold prices.

This week’s Chart of the Week compares gold prices to the MSCI ACWI Select Gold Miners Index. Typically, most investors would expect gold mining company returns to closely track those of gold prices. Perhaps surprising is that our chart shows that since 2010, gold prices have increased 52% while the gold miners index is down 8% over the same time-period.

Theoretically, gold mining company and gold returns should be relatively similar. In reality, though, there are many factors that cause a divergence between the two prices. For example, many mining companies will hedge a portion of their underlying commodity exposures, thus causing their earnings to vary. In addition, there are large capital costs involved with mining gold which can prevent a company from realizing the full benefits of rising gold prices.

Despite the continued lag in performance, gold miners appear attractively priced with a forward P/E ratio of 9.591. However, this week’s chart illustrates that investing directly in the bullion is the only way to ensure investors receive pure exposure to gold’s returns.

1 MSCI