Demand for Commodities Cools after Q1!
Investors Less Enthusiastic About Commodities after Crude Oil Price Rally Slows
The first three months of 2015 proved to be an especially profitable period for commodities trading. However, that energy has all but fizzled following the stalled rally in crude oil prices. During January, February and March of 2015, the net inflows into commodities totalled over $7 billion. That investment figure represents the strongest demand since 2012. However, as the price of oil and gas began to slow, commodities investors began to take profits. This resulted in net outflows from commodities funds of over $3 billion. Barclays analysts alluded to the strong reversals that took place during April and May 2015.
While crude oil prices rallied, investors were lured back into the commodities markets. This was driven by investor sentiment that the U.S. oil rig count was declining and helping to keep supply limited and push prices up further. But the oil price stopped rising and started to even out. When this happened, the volume of investments in oil exploration and research started to taper off. By March 2015, there was a general feeling that investments in the oil industry were declining. This is evidenced by the fact that just $800 million in energy investments were made compared to an average that was triple that amount during January and February 2015.
During April 2015, the iShares S&P GSCI Commodity-Indexed (ARCA:GSG) benchmark reflected a 5-year high return. The figure was up 11% but quickly receded by May 2015 where it remains. For the most part, commodities investments are now short-term oriented. Away from the energy sector, there appears to be a divergence taking place in the market. There is a general feeling that investors are well positioned for protection on the downside. However, there is a prevailing opinion that long-term investments in the commodities sector are not the way to go. These will likely become relevant towards the end of the year, when the growth in equity markets causes investors to shift focus into the commodities markets.
The Price of Crude Oil
The near-term price of crude oil is lower than crude oil’s future price. As a result, investors who maintain their positions in different types of commodities will incur additional costs when they roll them over. This also discourages long-term holdings of commodities. Gold traders and investors are carefully mulling the rate and timing of the first Fed interest rate increase in almost 9 years. Various economists are expecting the rate hike to take place as early as September 2015. By that stage the investment inflows from commodities like gold and silver will be highly pressured – notable given that commodities funds inflows are already in negative territory.
WTI Crude Oil is trading at $60.72 per barrel (May 22) and Brent Crude Oil is trading at $66.54 per barrel (May 22). The 1 year forecast for oil is $69 per barrel. Falling oil prices are also impacting heavily on many major oil producers in the Persian Gulf. As competition heats up between U.S. shale oil producers and Gulf producers, falling prices are impacting heavily on producers. Not everyone agrees that the price decline is negative however. Falling prices have assisted regional producers to take stock of their operations and aim for improved efficiency and diversification.
UAE-based Crescent Petroleum CEO Majid Jafar is of the opinion that the falling oil price has been a positive development for the region. With a renewed focus on diversification and greater efficiency, producers are able to optimize their production capacity. Equally important is the fact that countries in the Middle East who are importing oil have benefited from the lower prices and in so doing generate greater savings. The sharp fall in oil prices is evident from the drop from $120 per barrel a year ago, to approximately $60 - $66 per today (WTI and Brent Crude). As the demand for oil weakened, the price declined. But there are other factors weighing on the falling oil price, such as increased U.S. output and a strong U.S. dollar.
Naturally, the price of crude oil is largely determined by what OPEC countries like Saudi Arabia decide to do. In this case, the Saudis have refused to reduce output for fear of losing market share. They do not want to allow U.S. oil producers to gain at their expense, so production continues unabated. That the costs of producing oil are higher in the U.S. (higher wages, relocation fees for drillers and families, regulatory expenses, nature of wells etc.) does not help the U.S. productive and competitive capacity.
Factors Influencing Global Demand
Another issue that could turn oil prices upside down is the re-entry of Iran into the international oil markets. If a million barrels of oil from Iran flood the markets, prices could drop further. But according to Saudi Arabia’s oil minister, this issue is not significant. The reason being, that quantity of Iranian oil would take several years to reach the markets, compared to the millions of barrels that the U.S. is adding annually.
What is more important is how the U.S. responds when prices are lower and how the Chinese will react given their economy’s lagging fortunes. Just recently, the Chinese central bank made the third interest rate cut in 6 months. Should China’s demand decrease, the price of oil will decrease further. Further price declines in oil are expected before the recovery takes root. Based upon the fundamentals, there is little reason to believe that the present prices are not reflective of the realities in the market. Further drops in the price of crude oil could see the commodity hitting fresh new lows.