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Expert Perspective

News, research and market insights from our team of experts.

Investment e.Perspective

Current Issue | April 27, 2017

Opportunities in the Midst of Chaos

By: Jared Nishida, CFA, Senior Investment Strategist & Oxford Investment Fellow


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:

  • Global commodity producers – Current commodity prices have created an opportunity to own low-cost producers at very attractive valuations. These low-cost producers are negatively impacted by the current environment, but they are somewhat protected by their low-cost advantage. The upside potential and significant margin of safety afforded by the current market prices make this an attractive area even as uncertainty surrounding fundamentals continues.
  • Master Limited Partnerships (MLPs) – MLPs have recently exhibited a high correlation to changes in oil prices despite the fact that a large portion of the revenues are fee-based and dependent on volume, not oil prices. Falling prices have led to rising distribution yields that approach 6% on average. Yield spreads to the 10-year Treasury yield and high yield bonds are well above average. Valuations have significantly improved for MLPs over the last year, but there is also an expectation that the growth once envisioned could be tempered by sustained energy production cuts and higher costs of capital. MLPs offer a relatively attractive way to access yield.
  • Long-only commodity futures – An attractive return in commodity futures is now completely dependent on rising spot prices. Unlike past cycles, low interest rates offer no return on collateral while upward-sloping futures curves create a “negative roll” which further reduces any gains from rising prices. This remains an inefficient and structurally disadvantaged way to access commodity exposure.

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.