Seasonality is going against commodities

Transcription

1 SEPTEMBER 2016 The analysis of Thierry Masset Janet Yellen rebuffs pressure to hike Markets held hostage to rate Seasonality is going against commodities The peso as U.S. election barometer Debt alarm keeps ringing louder for China An oil gamble that has no precedent OTHER ASSET CLASSES Seasonality is going against commodities For commodities, 2016 started with a bang. If history is any guide, it could end with a whimper. The S&P and Goldman Sachs index, tracking returns for 24 components, is heading for a third-quarter slump (-10% in euro) after posting consecutive gains in the first two periods (+9%). Since the data begins in 1991, that s only happened in four other years - and the final quarter was a loser for three of them. Losses were led by agriculture (-13%) and energy (-10%). Since 2013, investors have made broad withdrawals in the second half of the year. The driving boom that typically boosts gasoline demand during U.S. summer months ends in September. That s the same month when natural gas inventories approach their peak, refinery maintenance curbs demand for crude and U.S. grain harvests add to supplies, according to Citigroup. With supply gluts persisting from corn to oil, traders are already gearing up for declines. Investors pulled $791 million out of exchange-traded funds tracking commodities over the past month, a reversal from earlier this year that have still left inflows up by $34.1 billion for the year. Hedge funds have cut their combined wagers on a rally for raw materials in nine of the past 11 weeks, and open interest across the asset class has fallen. Over the past month, about $991 million was pulled from energy ETFs and $39 million from industrial metals. Precious metals saw $530 million of inflows, but that pace has slowed from earlier this year. Investors are retreating after some raw materials had their best first half in eight years, outperforming sovereign bonds, the dollar, world equities and high yield and investment grade corporate bonds. From December 31 to September 23, prices were pulled higher by a 22% jump in gold prices and a 40% jump in silver prices and similar advance in natural gas, the biggest components of the S&P and Goldman Sachs Index. Money piled into commodities on speculation that

2 the Federal Reserve would be slow to raise U.S. interest rates, weakening the dollar and making commodities cheaper for holders of other currencies. The second half of the year could be a story of an inability or perceived inability for commodities to move much higher because big supplies are still weighing on many markets (oil, industrial metals, and agriculture) and because traders see a 60% chance that the Federal Reserve will raise interest rates by year-end, sparking advances for the dollar (which is negatively correlated with commodities prices). Furthermore, many producers are still grappling to contain debt. One gauge of leverage among mining, energy and agriculture companies continued to rise since the beginning of the year and is more than four times year-earlier levels. That explains why we keep a careful approach on this asset class with a neutral weight. While raw materials have rebounded, they are still well below levels of even two years ago. To end the gluts that sank prices companies ought to be cutting more output, but many are still so deeply in debt that they need to keep churning out cash to stay above water. Cutting production is absolutely the last resort for any company because in this case they are basically shutting down their revenue generation. And then what? Unless commodity prices extend gains, the conundrum holds grim consequences for 2016 for some producers. The debt burden is growing for many miners and drillers no matter how hard they pump and dig. Corporate defaults will reach a six-year high, led by commodity companies, according to Moody s. The cure for low prices may just be low prices. Declining profit means producers cutting investments in mines and oil rigs. When gluts do finally ease, it will spark a rebound. For now, demand is being overshadowed by the amount of supply that we have. We are already seeing signs of the market re-balancing but it s just going to take more time before we see more sizable supply rationalization. 3.1 Precious metals: overweight Gold While the prospect for higher rates means enthusiasm for gold is waning the interest in bullion since August (total assets in exchange-traded funds backed by gold fell by almost 24 tons to 2,019 tons), the increase in investment demand since the beginning of the year helped to make gold one of the best performing assets of the year (+22% in euro), comfortably outperforming many equity indices, bonds, commodities and real estate. For the record, investors bought record amounts of gold in the first half as concerns over Britain s vote on European Union membership and U.S. presidential elections drove demand for a haven. Slumping yields also reduced appetite for alternatives like stocks and bonds. Purchases of 1,064 metric tons smashed a 2009 record by 16% (in the second quarter alone, investor demand more than doubled to tons from a year earlier). In the same time, the net-long position in gold futures and options jumped to 279,000 contracts, according to Commodity Futures Trading Commission. That s the highest since August 2011!

3 Furthermore, central bankers from Tokyo to Stockholm have embraced the notion of negative rates. While, in theory, the approach could bolster growth by charging lenders fees for parking money at central banks, investors have worried it may rattle money markets. In this context, lower rates are a boon for gold, which becomes more competitive against interestbearing assets. Gold, even at a yield of 0%, may prove to be a higher yield relative to other assets during a time when interest rates are eroding capital globally. Investors turn to gold when faith in their currencies and financial systems is shaken. History shows that, in periods of low rates, gold returns are typically more than double their long-term average, the World Gold Council. Over the long run, negative interest rate policies may result in structurally higher demand for gold from central banks and investors alike. Countries seeking to weaken their currencies turn their population into gold buyers, as has been the case in China, Russia and other Emerging Markets. Gold is used as a currency, one that cannot be directly changed by central bank whims. We are also positive on gold because the precious metal is set to benefit from the potential for further market instability. Chinese/global slowdown, political instability in Europe, low commodity prices and doubts regarding the effectiveness of monetary easing could increase volatility on financial markets. This could keep risk appetite in check and U.S. dollar rates low, supporting gold. Central bank gold sales historically resulted in a market surplus, World Gold Council data shows. But from the second quarter of 2009 through 2015 net gold purchases by central banks absorbed most of the surplus, which may continue as reserve portfolio diversification is pursued. This may be particularly true if jewelry and investment demand weaken. Bloomberg estimates that central banks accumulated more than 2,448 tons of the metal versus gold exchange-traded fund outflows of about 270 tons in the period Silver Silver s bull run looks like it has legs. The metal with one of the best return this year of any in the Bloomberg Commodity index is poised for more gains, investors, traders and market data suggest. The metal is up more than 35% (in euro) since the beginning of the year after underperforming gold in the first quarter on concerns slow Chinese growth would curb demand in the biggest consumer of commodities. Silver hasn t been so cheap relative to gold for more than seven years and with mine supplies forecast to contract this year that may be a sign it s ready to come out of the yellow metal s shadow. An ounce of gold bought about 68 ounces of silver last month, more than any time since the financial crisis of Mine production of silver will probably drop in 2016 (-2.4% to million ounces, according to CPM group) for the first time in over a decade and demand is set to outstrip supply for a fourth straight year. Much of the world s silver is extracted from the ground with other minerals, and output cuts announced by the biggest miners will hurt supplies of the metal as well as others such as copper and zinc.

4 For investors who believe gold will keep climbing on worries about a global economic slowdown, deflation and negative interest rates, silver, could become a more profitable alternative. Typically the metal outperforms when the price of gold is rising and generally underperforms only when both are falling. More than 50% of silver (a by-product in mines that produce zinc, lead, copper and gold) demand comes from industry, including about a quarter from electronics, and to some extent silver s fortunes follow those of industrial raw materials such copper, zinc and lead. The London Metal Exchange index of six metals has climbed about 10% (in euro) since slumping to the lowest level in more than six years in February. Assuming the world economy avoids a sharp downturn and prices of industrial metals continue to stabilize, silver could outperform gold. 3.2 Crude oil (Brent): neutral The Organization of the Petroleum Exporting Countries (OPEC) discussions on output in Algeria later this month and Vienna in November look more difficult with revised International Energy Agency (IEA) forecasts indicating supply cuts, not a freeze, are needed to rebalance the oil market. Arguments that the oil market was already balancing weakened when the IEA that the global surplus will last longer than previously thought, persisting into late 2017 as demand growth slumps and supply proves resilient. The agency cut its global oil demand forecast by around 200,000 barrels a day throughout 2017 amid "fading" stimulus from cheaper fuel, and "economic worries in developing countries." With Gulf OPEC countries' crude output at, or near, record levels (Gulf OPEC states are currently pumping crude at or near to 10-year highs), a freeze will do little to help restore a market balance. As such, a cut in production levels, rather than a freeze, is the only way there will be any tangible impact on supply. As long as rivals Saudi Arabia and Iran agree on the supremacy of low-cost oil producers, there can be little incentive for them to throw a lifeline to their higher-cost rivals. Furthermore, the oil glut could worsen as two OPEC crude producers (Nigeria & Libya) whose supplies have been crushed by domestic conflicts are preparing to add hundreds of thousands of barrels to world markets within weeks.

5 The combination of faltering demand and increased OPEC output pushed oil inventories in developed nations to a new record in July, at 3.1 billion barrels. In this context and as the U.S. oil supply glut is failing to clear, we keep our neutral positioning on Brent. The issue is that once prices go up too fast, American drillers start to produce more. 3.3 Industrial metals: neutral The world s two largest mining companies are planning to raise capital expenditure from decade lows as a rebound in commodity prices (the World Bank forecasts commodities will rebound next year after hitting the bottom of the cycle) and the improved cash flow outlook pave the way for at least $12 billion of growth projects. BHP Billiton, the No. 1 miner, expects to raise spending by 15% in fiscal 2018, while Rio Tinto forecasts it will boost expenditure from next calendar year. Any significant rise in the oil price could mean mining companies boost spending further. However, we see capital expenditure remaining lower than at the height of commodities boom. BHP s annual spend peaked at about $21 billion in fiscal Furthermore, mining executives may be placing too much confidence in China s ability to support economic expansion, a factor that has lifted demand and commodities prices this year. China s growth remains set for a long-term, slow decline. While they are unlikely to repeat the selloff seen last year, price weakness will continue in industrial metals, owing to a combination of excess supply and soft demand. The outlook for metals continues to be bearish as supply curtailments come off in China and elsewhere. Many producers are still grappling to contain debt. Another year of belt-tightening hasn t kept pace with an earnings slump after prices collapsed. One gauge of leverage among mining, energy and agriculture companies continued to rise and is more than double year-earlier levels.

6 3.4 USD (neutral) and Yen (positive) The sixth straight Federal Reserve (Fed) decision to hold interest rates lifted most currencies worldwide against the US dollar, with the gauge of the USD against 10 major peers extending decline as it heads for its first annual drop in four years. The more Haruhiko Kuroda does, the more convinced traders become that the yen s appreciation is out of his control. The latest Bank of Japan s decision marked the fifth straight meeting that saw the yen gain by the end of the trading day. The yen slipped as much as 1.1% to a one-week low of per dollar soon after the BoJ s decision, only to recover all those losses to end the day higher. The Japanese currency has surged 20% this year, the best performer among 10 major developed peers, set for its biggest annual advance since Making its policy menu more complex only led markets to believe the BOJ faces limits. Governor Kuroda and his board shifted the focus of stimulus from expanding the money supply to controlling interest rates, pledging to pin benchmark 10-year yields around zero. The central bank would adjust the volume of its asset purchases as necessary in the short term to control the bond yields, while keeping it at about 80 trillion yen ($797 billion) annually over the long term. The BoJ at the same time scrapped a target for the average maturity of its holdings of government bonds. While the bank strengthened its forward guidance by committing to an overshoot of consumerprice gains, it refrained from moving deeper into negative interest-rate territory. Strategists questioned whether the BoJ can control the so-called yield curve (particularly at the longer end of the curve) as it envisions. Kuroda already faced skepticism that the yield curve strategy is a smoke screen for paring bond purchases. While the BoJ may be able to contain yields from an overshoot and guide them towards zero for 10-year notes using the new operations, it is unclear how the bank can cope if yields drop to lower levels than those policy makers deem appropriate. The BoJ has only two options - sell long-term government bonds or forgo buying operations - when doubts about inflation and the economy raise speculation about more BoJ stimulus and push down yields. If the first option is unrealistic, it seems difficult to lift yields just using the second option. Skepticism about the odds of success for Abenomics, Prime Minister Shinzo Abe s economic revival program, may rise if the BoJ is judged to be struggling with the limits of the aggressiveness that marked the first years of Governor Haruhiko Kuroda s tenure. While Governor Kuroda denied any intention of scaling back the amount of bonds the BoJ buys, or tapering, the currency market s reaction shows traders saw it as a tightening step rather than an easing one. Whether it s tapering or not, aiming to peg 10-year yields around zero means a reduction in bond purchases will become inevitable. Many market players associated more bond buying with a weaker yen, so scrapping that would naturally mean for them a yen buying factor. Central banks in developing economies are taking advantage of the biggest rally in their currencies since Led by Turkey and Thailand, they are using stronger exchange rates to build up foreign reserves for the first time in two years, replenishing shortfalls created as they attempted to prop up their currencies during recent routs. International reserves have grown by $154 billion, or 1.4%, since the end of March to $11 trillion, according to data compiled by Bloomberg. Turkey s cash coffer expanded the most during the period, increasing more than 6%. Thailand s currency pile rose 5.5%, while Indonesia s climbed 3.6%. Bigger defences mean they will be able to better ride out destabilizing plunges as they make their economies more appealing for traders. The increase marks a reversal since 2014 when capital outflows prompted central banks from China to Saudi Arabia to burn through hoarded cash to stem declines in their currencies. Global reserves peaked at $12 trillion in August that year and had been declining until recently when capital started to flow back into Emerging Markets. With more than $10 trillion of bonds in Europe and Japan yielding below zero, developing-nation assets are becoming attractive for yield-starved investors just as their economies show signs of recovery. More and more money is being put into Emerging Market bonds and equities and it s giving them opportunities to buy dollars and replenish reserves.