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Price Asset Management
The Commodity Curve

January 2016

Commodities 2016: So, What’s Different Now?

The law of supply and demand battered many commodities in 2015 with the energy sector leading the way. In addition, a strong dollar, mid-year fears regarding Greece, and then a slowdown in the growth rate in China all contributed towards many commodity prices dropping to multi-year lows. But the most asked question we hear today is not if commodities will recover to once again provide diversification benefits, non-correlation and protection from inflation; but rather when? What is it going to take for commodity prices to really begin this long awaited mean reversion process? What is different today from where we were a year ago?

As we enter 2016 and sift through the mass of negative opinion, a number of fundamentals have in fact changed with the potential to ignite the beginning of the recovery.  As we know, historically speaking, when commodities rebound they have tended to do so quickly.

Let’s Analyze

We believe there are a number of fundamental catalysts that have been put into place over the last year across each of the sectors; some of which we summarize below:

  1. Energy prices are now over 60% LOWER than they were in September 2014 and the dramatic decline has indeed caused a dramatic response. It is estimated that there are now over $380 billion of capital expenditure cuts across 68 major oil and gas projects worldwide. This is up from an estimated $200 billion just 6 months ago!1

    Producers are feeling tremendous stress from low prices. This includes the international non-OPEC producers, where even state-run companies in Indonesia and Thailand are cutting their capital expenditures. In 2015 in North America alone, there were 42 energy-related bankruptcies, the most since 2008.2

    At the same time, worldwide demand for oil in 2015 was at a 5 year high,3 China’s oil consumption continued to grow,4 and 12-month total vehicle miles driven in the U.S. set an all-time record!5

  2. The Mining industry saw a rapid proliferation of major capital expenditure cuts and in 2015 the cuts have now transitioned into the actual closing of numerous mines by the largest mining companies. Glencore, BHP, Freeport McMoran and Anglo American, to name a few of these major companies, are closing mines and decreasing production in Copper, Nickel, Zinc, and Aluminum. In fact, Anglo American, the fifth largest by market cap, announced layoffs of 85,000 people ultimately leaving 50,000 at the company, while at the same time selling or closing 60% of their existing mines.6

    The reduction of supply is a key factor in setting up for higher prices: tight supplies drive prices.

  3. Agriculture has its own unique catalyst this year in the form of an El Niño, which is currently in full affect. Since 1980, there have only been 8 previous El Niño's weather patterns and on average the agricultural sector prices rose 24% over the 12 months following the end of an El Niño.7 This current El Niño is expected to peak this winter and have run its course sometime around late spring.  Wheat, Corn, Soy Beans, Sugar Coffee and Cotton have, on average, benefited the most from this type of event.

Copper’s Getting Wired

For example, The International Copper Study Group (ISCG), in October, revised its forecast from a previous prediction of a surplus to a deficit of copper in 2016 due to the numerous announcements of production cuts and mine disruptions. "The revisions reflect substantial changes in market conditions since April 2015," ICSG stated, “Although a downward revision has been made to global usage in view of lower than anticipated growth in China, larger downward adjustments have been made to production* as a result of recent announcements of production cuts.”

(The ISCG was established in 1992 in order to promote international co-operation on issues concerning copper by improving the information available on the international copper economy and by providing a forum for intergovernmental consultations on copper. http://www.icsg.org/)
*Bold text formatting added by Price Asset Management, LLC.

Sweet Moves

Additionally, Sugar prices were at an 8-year low in August of 2015, driven by negative sentiment and seemingly poor fundamentals. Over the next 4 months sugar rallied nearly 50% due to global supply issues and difficult weather patterns.

“Now, after five years of statistical surplus, the world sugar economy is expected to enter a deficit phase*” the International Sugar Organization (ISO) announced in a November 2015 report. The ISO raised its forecast for next year’s global sugar deficit by 40%, to 3.5 million tons, and that’s based on a neutral-weather assumption.

(The ISO is an intergovernmental organization whose vision is to be a center of excellence as the 'first-best' provider of comprehensive information to the global sugar community. http://www.isosugar.org/)
*Bold text formatting added by Price Asset Management, LLC.

Timing & Effect

This cycle for the commodity asset class has resulted in one of the longest bear markets on record with most prices currently at multi-year lows. The length and steepness of this cycle may in part be due to the Fed’s zero interest rate policy which led to producers taking on large debt loads but with very low interest rates and easy credit thus allowing them to delay the reaction to low prices far longer than in previous cycles.

With the supply responses that have occurred over the past year and continuing into 2016, it appears we may be setting up for a repeat of previous historical rebounds perhaps similar to the recovery after the 1997-1998 bear market low and creating a foundation for higher prices over the years to come. In addition, there are unpredictable events such as an unexpected change from OPEC, disruptions due to global tensions, the reversal of the US dollar strength, or even the historic winter storm just hitting the east coast a few days ago, which may also have an impact as supplies continue to shrink.

Final Word

Many commodities and overall sectors will respond to their own specific supply and demand dynamics. A number have clearly improved over the past year but, as specialists in commodities, we know that exact timing is difficult to get right. When the tipping point arrives for most commodities, prices tend to recover very quickly. Thus it pays to be invested, at least partially, during the earlier parts of an asset class recovery. That is why we believe now diversified investors should own the asset class now or, if not currently invested, begin to allocate in a disciplined manner. With the overwhelming negative sentiment, depressed prices, and improving fundamentals, this recovery appears poised to occur more rapidly than most investors currently expect.

The Rogers International Commodity Index®, with 37 components; 34.9% agriculture, 40% energy, and 25.1% metals, is a broad, international raw materials index methodology providing, in our opinion, best-in-class exposure to the commodity asset class.

For more information visit:
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Sources: 1Wall Street Journal, 2Reuters, 3International Energy Agency, 4China NBS, China OGP, Jefferies, 5US Federal Highway Administration, 6Anglo American Press Release, 7S&P Dow Jones Indices.

 
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Index Descriptions

RICI® (Rogers International Commodity Index®): Comprised of 37 commodity futures representing the energy, metals, and agriculture sectors. The components of the RICI® have been specifically chosen to give a balanced representation of consumption patterns throughout the world. The RICI® was first published on August 1, 1998.  CQG Inc. is the official global calculation agent for the Rogers International Commodity Index® (RICI®).

Disclaimer

The Index returns shown in this presentation do not represent the results of actual trading of investable products, assets or securities. It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available only through investable instruments based on that index and there can be no assurance that investment products based on the index will provide returns that are similar to the actual index performance provide positive investment returns. All the indices referred to in this presentation above are not investable products and their returns do not reflect the fees and charges inherent in investing in a vehicle designed to replicate a particular index. Any Index performance provided is for illustrative purposes only.

Exposure to the Rogers International Commodity Index® is typically gained by investing in “alternative” investment products that are linked to the performance of the RICI®.  Alternative investment products may entail leveraging, commodity trading and other speculative investment practices which involve substantial risk of loss.  Alternative investment performance can be volatile.  Not all products are suitable for all investors and some products may only be available to certain qualified and sophisticated investors.

“Jim Rogers”, “James Beeland Rogers, Jr.”, and “Rogers” are trademarks and service marks of, and “Rogers International Commodity Index” and “RICI” are registered service marks of, Beeland Interests, Inc., which is owned and controlled by James Beeland Rogers, Jr., and are used subject to license. The personal names and likeness of Jim Rogers/James Beeland Rogers, Jr. are owned and licensed by James Beeland Rogers, Jr. Products based on or linked to the Rogers International Commodity Index® or any sub-index thereof are not sponsored, endorsed, sold or promoted by Beeland Interests, Inc. (“Beeland Interests”) or James Beeland Rogers, Jr. Neither Beeland Interests nor James Beeland Rogers, Jr. makes any representation or warranty, express or implied, nor accepts any responsibility, regarding the accuracy or completeness of this report, or the advisability of investing in securities or commodities generally, or in products based on or linked to the Rogers International Commodity Index® or any sub-index thereof or in futures particularly.

This report does not constitute an offer to sell, or a solicitation of an offer to buy or sell, any commodities interests, managed futures accounts or securities, and is intended for informational purposes only. Any offer for any investment product will be made solely by the appropriate disclosure document or offering memorandum. Price Asset Management, LLC does not make any representations as to the accuracy or completeness of any data or information contained herein and such information should not be relied upon as such. Some data and information presented on this site may have been obtained from outside sources.

Investments in commodities, managed futures and other alternative investments involve a high degree of risk and performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Investments in commodities, managed futures and other alternative investments are often executed on non-U.S. exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in U.S. markets. Past performance is not indicative of futures results.

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