Topic Tags: Commodities

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

Interest Rates the Fertilizer for Farmland Prices?

This week’s chart of the week looks at the growth in mid-west farmland prices. Our chart shows the increase in farmland prices in Illinois, Indiana, Iowa and the Federal Reserve 7th District, which includes all three of these states.

This week’s chart of the week looks at the growth in mid-west farmland prices. Our chart shows the increase in farmland prices in Illinois, Indiana, Iowa and the Federal Reserve 7th District, which includes all three of these states. While this may surprise many investors, mid-west farmland has been one of the best performing investments over the last decade, up 12.3% annually. Higher crop prices and a shrinking supply of available high quality farmland drove this increase in farmland prices. Since both of these trends seem likely to persist into the future, institutional investors have begun to invest in farmland to take advantage of these trends. However, as our chart shows, the other driver of higher prices has been the persistent fall in interest rates which lowers the carrying costs (i.e. interest payments) of owning farmland for both farmers and investors. Given the recent rise in interest rates over the last few months it seems reasonable to question if farmland prices can continue their upward trajectory without the benefit of further reductions in interest rates.

Lower Oil Prices: Good News or Bad News?

In the last week, U.S. crude oil prices hit a three month low dropping below $88 a barrel, attributable to economic slowdowns in China, Europe, and the U.S. Further downward pressure on oil prices has been caused by reduced earnings forecasts by U.S. corporations, unmet expected profits, and the growing worries for lower growth across the global economy.

In the last week, U.S. crude oil prices hit a three month low dropping below $88 a barrel, attributable to economic slowdowns in China, Europe, and the U.S. Further downward pressure on oil prices has been caused by reduced earnings forecasts by U.S. corporations, unmet expected profits, and the growing worries for lower growth across the global economy. Crude oil inventories rose by 5.9 million barrels to a total of 375.1 million barrels, the highest since 1982.

This drop in oil prices will have mixed results for consumers. On the bright side, the lower prices may contribute to some relief for consumers at the pump, thus leaving additional room in consumer budgets for consumption of other goods and services – an accretive trend for GDP growth. On the other hand, the price drop is a symptomatic factor for a regressing weak global economy and suggests further slow growth.

A Hot Summer for Corn Prices

This summer’s unusually hot weather combined with little rain is shaping up to have a profound impact on corn yields for 2012. At the close of trading on Monday, corn futures settled at $7.75, up 40% since June 1, and 12% since July 1.

This summer’s unusually hot weather combined with little rain is shaping up to have a profound impact on corn yields for 2012. At the close of trading on Monday, corn futures settled at $7.75, up 40% since June 1, and 12% since July 1. These radical increases in price are a clear reflection of small yields for corn, and thus lower supply to meet both domestic and foreign demand. Further compounding the corn outlook is weather forecasts, which continue to predict below average rainfall for the next few weeks. As a result, we are likely to see further increases in corn prices.

What does it all mean for investors? If one is long corn via a futures contract or commodities fund, this news is likely accretive. However, for companies that rely on corn as a key input for production, this represents an added cost of production and a drag on profitability. For consumers, higher corn prices will probably equate to higher grocery bills.

Stock up on Soybeans in 2012

This past Friday, March 30th, the United States Department of Agriculture (USDA) released the 2012 Prospective Plantings report, which included various estimates. According to the report, “Soybean growers intend to plant an estimated 73.9 million acres in 2012, down 1 percent from last year and down 5 percent from 2010.

This past Friday, March 30th, the United States Department of Agriculture (USDA) released the 2012 Prospective Plantings report, which included various estimates. Amongst the estimated data, the Prospective Planting report included a lower than anticipated soybean forecast. According to the report, “Soybean growers intend to plant an estimated 73.9 million acres in 2012, down 1 percent from last year and down 5 percent from 2010. Compared with last year, planted acreage intentions are down in many areas as some acreage is expected to shift to corn” (USDA).

The projections on soybeans from the USDA indicate that soybean ending stock is expected to reach dangerously low levels. After the release of the USDA prospective planting report, soybean future prices quickly skyrocketed as anticipated rationing of soybean stock will most likely result throughout the year. The price of soybeans ended up over 3% from the previous day’s close indicated from the chart above. Although it may be too late for U.S. farmers to switch acres to soybeans this season due to the fieldwork they have already completed, the higher prices have the potential to entice South American farmers to switch during their next planting season. This additional soybean production will be necessary to fulfill Chinese demand as they continue to be a dominant player in the agricultural market.

Sources:

  • USDA Prospective Plantings report
  • Farm Press Article: by Dr. Scott Irwin, Dept. of Agriculture and Consumer Economics, University of Illinois
  • Bloomberg article – China reference

Lower Oil Prices?

Domestic energy production has experienced a renaissance over the last few years, mainly driven by natural gas production. While oil prices hovered around $100/barrel for most of 2011 natural gas prices hit lows not seen since the 1990’s.

Domestic energy production has experienced a renaissance over the last few years, mainly driven by natural gas production. While oil prices hovered around $100/barrel for most of 2011 natural gas prices hit lows not seen since the 1990’s. As this chart shows, the relative price of oil to natural gas (shown in gold) was fairly stable during the 1990’s and most of the 2000’s but has soared over the last few years. In the short term some divergence is understandable, but over the long term these two energy sources are substitutes and we would expect to see energy consumers switch from oil to natural gas given the price differential.

The line in gray shows the number of natural gas drilling rigs in the U.S. and the explosion of drilling in 2006 and 2007 led to the increased production and lower prices we see today. What is also interesting is natural gas drilling activity has remained fairly stable over the last two years while oil drilling activity has reached levels not seen in the last twenty years (black line). Will the increase in oil drilling lead to more production and lower prices? If natural gas is any indication, Americans might see more oil production and lower prices at the pump in the years ahead.