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What does the oil slump mean for investors?

It wasn’t so long ago that commentators used to talk about a “commodities super-cycle”. However, commodities have had a pretty grim run for a prolonged period now. Indeed the Bloomberg Commodity index* has posted negative returns for three consecutive 12-month periods.

Jason Hollands Jason Hollands
02 December 2014

This week it has been the rout in oil prices that has taken centre stage. Oil prices have been on the slide for months now – down 36% in six months – and that's despite the threat to production from the turmoil in Iraq and Libya. For that we can thank the booming US shale oil industry, which has in turn prompted the Organisation of the Petroleum Exporting Countries (OPEC) to respond with an aggressive supply strategy. At its meeting last week, OPEC reaffirmed there would be no let-up in the pace of production which remains at 30 million barrels per day, a move which has sent prices spiralling ever lower.

So, is now a good time to capitalise on weak prices and invest in commodities?

While it often makes sense to invest in a market or asset class after a sharp decline, in the case of commodities we believe the asset class faces a number of headwinds that are unlikely to disappear anytime soon.

These are:

  • Global growth remains weak, reflecting an overhang of debt and structural misallocation of capital. China in particular faces challenges, with its growth now slowing and the country needing to adapt its economic model away from one that has been over-reliant on the kind of internal investment which has made it such a voracious consumer of raw materials.
  • Structural oversupply. Investment decisions made during the ‘commodity super cycle’ era are now coming to fruition. As a result, many commodity markets are in surplus for the first time in over a decade. Market imbalances caused by oversupply often take extended periods of time to correct.
  • A renaissance in the US dollar. History suggests that commodities typically struggle during periods when the US dollar rallies as it raises their cost in local currency terms. Dollar cycles usually last around six years and involve a 35% movement, peak to trough. This cycle started in 2011 and has so far seen the dollar appreciate by 20%.

These factors lead us to believe that commodities are in an extended period of adjustment that may not yet have fully played out. We also believe that commodity markets are likely to prove dull at best, suggesting that better investment opportunities exist elsewhere. Indeed radically lower energy costs will help fuel (forgive the pun) some of those opportunities.

Low oil prices are clearly bad news for major exporting nations such as Russia (energy stocks represent over 56% of the MSCI Russia Index), Nigeria and Malaysia, each of which has seen its currency under pressure in tandem with the downward shift in oil prices.

However, for major net energy importers, such as Japan (which has relied heavily on imported energy since the suspension of its nuclear reactor programme), India, South Korea, Western Europe and Turkey, cheaper energy provides an economic boost both to businesses and consumers. For Japan and Europe, both of which are implementing accommodative monetary policies, reduced energy costs will provide an additional form of stimulus.

For the UK it is a double-edged sword – while businesses and consumers will cheer lower energy costs, from the Chancellor’s perspective, there is a negative impact on tax-receipts from North Sea oil.

 

* https://www.bloomberg.com/quote/BCOM:IND/chart

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers. Past performance is not a guide to future performance.

Funds which invest in specific sectors may carry more risk than those spread across a number of different sectors.  In particular, gold, technology and other focused funds can suffer as the underlying stocks can be more volatile and less liquid.