Commodity rally still has fuel

Thought of the day

by Chief Investment Office 04 Apr 2019

If early 2019 has been a story of mixed signals, you wouldn’t know it from the commodity sector. Crude futures have rallied nearly 30%, with Brent crude creeping back up near USD 70/bbl, while the broader Bloomberg CMCI commodity index has risen 10% for the year. Investors in the asset class have been undeterred by a glut of dovish central bankers, weakening macro data, growth forecast downgrades, and an inverting yield curve.

But far from running out of steam, we see additional gains for commodities ahead as they continue to benefit from a number of commodity-specific factors:

  1. Oil in low supply. OPEC and its allies continue to cut supply amid still-healthy demand growth. Russian oil output dropped by about 130,000bpd in March versus the October base line, while Saudi Arabia cut its production in March by about 220,000bpd from the previous month. Venezuela has struggled with power outages and sanctions, while some Trump administration officials are agitating for further action on Iran sanctions. We anticipate a balanced oil market this year, with Brent forecast at around USD70-80/bbl in 2019.
  2. Metal shines in China. Renewed fiscal stimulus has helped revive the outlook for metals. China FAI infrastructure growth rose to +4.3% y/y in Jan-Feb 2019, against a 3.8% y/y pace in 2018. Even as China’s overall imports contracted in early 2019, the share of major commodities such as copper, zinc and nickel ore, and coking coal – elements of firmer investment activity – grew in Jan-Feb this year. Alongside additional Chinese stimulus, metals should benefit from a neutral Fed and market deficits across the sector, with higher prices into a seasonally strong demand period through summer.
  3. Gold? Sold. Central bankers have returned to the gold market in force, with purchases of more than 650 tons last year, a near half-century high water mark. Add in the Fed's dovish pivot and the peaking of US real rates, and the expected weakness of the USD, alongside occasional equity market volatility spikes, and we think gold prices can climb to USD 1,350-1,400/oz in six to 12 months.

So despite the broad commodity rally this year, we continue to see attractive risk-reward opportunities for the asset class. We expect a high-single-digit rate of return for a broad basket of commodities in 2019, and maintain our preference for energy sector equities in Europe.

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