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Commodities – especially oil – remain hot topics of conversation among investors and commentators. This isn't surprising given the dramatic decline in spot prices. WTI crude has fallen by 50% over the last year. Natural gas and copper are 35% and 25% lower, respectively, over the same period.
China is slowing. OPEC is oversupplying. Shale plays are producing. The US dollar is rising. Take your pick. All of these issues have had a hand in the downdraft of the current commodity cycle. So where are we headed from here? We don't know (and neither does anyone else). Thankfully, we don’t need to know where prices will be tomorrow to capture attractive opportunities the market is handing us today.
There is always a well-reasoned argument for prices to be where they are and it is tempting to think the current environment will last forever. Commodity price cycles have occurred many times before and thinking "this time is different" is a dangerous position to take.
While we won't predict where oil is headed, it is useful to recognize the self-healing element to commodity prices that perpetuates the existence of price cycles. Because prices for nearly all commodities are below the global marginal cost of supply, the incentive to invest in new production is not there. For oil and gas producers, capital expenditure plans have been cut by 50% (if not more). The "rig count" (measure of active drills in the US) for oil production has plummeted as the economics of drilling have become much less favorable at current prices. The supply reductions from current wells along with substantial cuts in investments for future production will eventually help to balance supply and demand, setting the stage for the next upswing in prices. That's not a prediction, just acknowledgment of the path of least resistance.
From a portfolio perspective, it is important to remember the strategic importance of exposure to real assets and commodity-related securities. The needs and objectives of a client portfolio are typically impacted by changes in consumer prices. Maintaining exposure to these markets ensures part of the portfolio retains a positive relationship to overall changes in prices and inflation.
Given the current environment, below are Oxford's views on select opportunities in commodity-related investments:
Nobody knows what the future holds but we do know that opportunities are created in the midst of chaos. Specialist managers like the ones Oxford uses are finding opportunities of a generation in global commodity producers trading at deep discounts on par with the depths of the 2008 financial crisis. Like 2008, it can be difficult to stomach the volatility of this deeply cyclical asset class but the potential reward for the long-term investor merits exposure in a diversified portfolio.
The above article represents the opinions of the author as of 9.30.15 and is subject to change at any time due to market or economic conditions or other factors.Print