CIO Commodity Commentary

Commodity-market turmoil

Commodities are a very volatile asset class and they are staying true to form in this current crisis. Indeed a number of factors have coincided to make them particularly hard hit this time.

Let's start with the question of why gold, the traditionally perceived safe haven, did not gain amid all the turmoil? The stock markets have fallen by around a third year- to- date and central banks' adoption of lower interest rates ought to support the yellow metal, which does not pay interest. As the sell-off deepened, however, and liquidity became more constrained, investors were forced to tap their most liquid asset classes. Gold, whose market is highly liquid and developed, has therefore served as a source of funds for investors. But after the recent U.S. Federal Reserve (Fed) action we expect an easing of the selling pressure and some stabilization in markets to brighten the outlook. The low rate environment – reducing the opportunity cost of holding gold – and safe-haven demand are additional positive factors. The current development could be similar to the trend in gold prices during the global financial crisis: prices fell for much of 2008 but then rallied strongly in subsequent years.

While natural gas used to be our problem child, it is oil that has suffered the most across the commodities space during the past 30 days. Both demand and supply have been hit hard. On the supply side, large oil-consuming economies like India and China have already been severely affected by the coronavirus crisis, thereby weakening oil demand and prices. Saudi Arabia therefore attempted to persuade OPEC+ countries, which had agreed to cut production by 0.5 million barrels per day (b/d) in December, to cut by further 1.5 million b/d in an effort to stabilize prices. Russia's refusal to even abide by the previously agreed cut led Saudi Arabia to change its objective, targeting market share instead of a certain price level. By increasing its output, it drove prices further down. Russia's actions do not come as a surprise as it repeatedly did not adhere to previously agreed cuts exacerbating the cartel's fragility. The implications are profound. Additional stress has been brought to the credit markets. Most U.S. shale exploration and production (E&P) companies now cannot, at the greatly reduced prices, generate enough cash flow to fund their capital expenditure, so there will likely be further downgrades from the investment-grade space. Likewise, there are rising concerns over potential bankruptcies within the high-yield segment, and correspondingly yields in the U.S. energy sector have increased.

On the oil demand side the picture is also bleak as the coronavirus pandemic is essentially putting economies around the world on hold. Looking forward, we do not believe that the shift from price maintenance to a market-share-protection strategy will go on indefinitely. Lower oil prices not only force Saudi Arabia to run large budget deficits, but also hurt the income of the Royal family and force further share issuance by its large oil company to be delayed. Russia meanwhile is being put under severe strain by the price war, with its revenues down and the ruble tumbling to its weakest level in years, putting further pressure on the Russian economy. Although we do not expect the price war to continue indefinitely, it is likely to get worse before it gets better. Trust is a hard-earned commodity and will take time to rebuild. In 2015, for example, it was hard to restore OPEC and Russia's credibility with regard to the production cap.

The price war could hardly have been unleashed at a worse time. But further developments may involve a new kid on the block – the United States. Concerned about the struggling U.S. shale-oil producers, President Trump has said that he has ordered the Energy Department to fill the strategic petroleum reserve "to the top".[1] He has also said he would get involved "at the appropriate time" in the dispute between Saudi Arabia and Russia. These comments have helped to put a floor under oil prices. For now, we believe that it is unlikely that all three parties will come to the table directly. Future agreements will probably involve only a subset of them at first.

The latest U.S. Department of Agriculture World Aggregate Supply and Demand Estimate (WASDE) report was relatively uneventful. As expected, estimates of South American production were increased following an excellent growing season. Soft commodities were more affected by the broader risk-off sentiment, particularly sugar, whose price is linked to energy prices through ethanol demand, has fallen by about 15% this year. Assuming energy volatility persists, agriculture is likely to continue to trade in sympathy. Sugar and corn (ethanol), soybean oil and palm oil (biodiesel) and cotton (synthetics) will be most affected in our view. In the absence of a downward pull from energy prices, we are generally constructive on agriculture as food demand is relatively macro agnostic and is likely to suffer less than other commodities in the coronavirus crisis.

Past 30-day and year-to-date performance of major commodity classes

Past performance is not indicative of future returns.
Sources: Bloomberg Finance L.P., DWS Investment Management Americas Inc. as of 3/23/20

1Bloomberg Commodity Index, 2Bloomberg Natural Gas Subindex, 3Bloomberg Brent Crude Subindex, 4Bloomberg WTI Crude Oil Subindex, 5Bloomberg Gold Subindex, 6Bloomberg Aluminum Subindex, 7Bloomberg Zinc Subindex, 8Bloomberg Copper Subindex, 9Bloomberg Silver Subindex, 10Bloomberg Platinum Subindex, 11Bloomberg Wheat Subindex, 12Bloomberg Soybeans Subindex, 13Bloomberg Corn Subindex, 14Bloomberg Live Cattle Subindex, 15Bloomberg Cotton Subindex, 16Bloomberg Sugar Subindex


Appendix: Performance over the past 5 years (12-month periods)

02/15 - 02/16

02/16 - 02/17

02/17 - 02/18

02/18 - 02/19

02/19 - 02/20

Bloomberg Commodity Index

-26.6%

15.5%

0.5%

-7.7%

-12.8%

Bloomberg WTI Crude Oil Subindex

-51.1%

27.2%

9.3%

-5.8%

-22.2%

Bloomberg Brent Crude Subindex

-51.7%

32.8%

13.6%

4.2%

-16.7%

Bloomberg Natural Gas Subindex

-53.6%

13.6%

-22.6%

3.8%

-51.7%

Bloomberg Gold Subindex

1.3%

0.2%

3.2%

-2.9%

15.8%

Bloomberg Silver Subindex

-11.1%

21.2%

-13.3%

-7.5%

1.9%

Bloomberg Platinum Subindex

-21.6%

9.3%

-5.6%

-13.3%

-3.7%

Bloomberg Copper Subindex

-21.7%

24.6%

12.0%

-8.5%

-14.9%

Bloomberg Aluminum Subindex

-18.2%

19.3%

7.4%

-10.4%

-15.1%

Bloomberg Zinc Subindex

-16.8%

57.5%

21.9%

-16.1%

-24.2%

Bloomberg Corn Subindex

-18.3%

-4.7%

-10.7%

-15.1%

-10.1%

Bloomberg Wheat Subindex

-14.6%

-16.2%

-7.5%

-18.3%

10.7%

Bloomberg Soybeans Subindex

-15.7%

17.9%

-3.2%

-20.2%

-10.4%

Bloomberg Sugar Subindex

-5.1%

27.5%

-33.6%

-12.3%

0.6%

Bloomberg Cotton Subindex

-15.1%

32.4%

9.1%

-13.4%

-18.4%

Bloomberg Live Cattle Subindex

-9.0%

-5.0%

5.4%

4.7%

-19.0%

Past performance is not indicative of future returns.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 3/23/20

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