Commodities are cyclical investments holding value driven largely by the economic principles of supply and demand. As prices fall, supplies are cut and/or demand increases. The reverse is also true; if commodity markets are in surplus, the prices fall until the lower prices spur enough demand to reach equilibrium. So, the market price for commodities should naturally be determined by the normalizing of imbalances between supply and demand. This means that a range of potential variables, including production, weather, inventory, inflation, and both population and economic growth can impact commodity prices.
One need only examine Figure 1 below to conclude that timing is important when trading commodities. It may go without saying, but the commodity market has generally not been kind to investors over the past five years, due primarily to the global slowdown that has occurred since 2014. Conversely, investors taking positions in the commodities market in early 2009 during the height of the financial crisis were quite pleased with returns two years later, as the subsequent recovery in global economic markets provided outsized returns for investors who were willing to assume these risks.
Global Price of All Commodities
01/2006 – 01/2016
Source: International Monetary Fund, Global Price Index of All Commodities© [PALLFNFINDEXQ], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PALLFNFINDEXQ, February 17, 2017.
In the case of the commodity investments, the consistent macroeconomic value-drivers raising most boats tend to be global growth and inflation. Based on empirical data, both appear to be on the threshold of returning to an early-phase growth cycle, supported by pro-growth economic policies within the United States and excess liquidity throughout the world.1 However, the global economy continues to face elevated risks to growth as a result of growing geopolitical risks, currency risks, burgeoning debts, protectionism, and potential trade wars.
So, how can risk-averse investors take advantage of seemingly attractive investment opportunities in the cyclical commodities market, while maintaining controls over portfolio volatility and risks?
The MarketSafe® Core Commodities CD
Introducing the MarketSafe Core Commodities CD, a five-year indexed, U.S. dollar-denominated deposit product offering 100% deposited principal protection2 with potential upside exposure to four equally weighted commodities: West Texas Intermediate (WTI) oil, gold, sugar, and copper.3 No annual percentage yield or periodic rate of interest is paid on this CD; instead, the potential “upside payment” at maturity is based on the average return of the four commodities based on 10 semi-annual pricing dates throughout the life of the CD. There is no cap to the potential upside payment and OID reporting rules apply.4
The initial price of the four commodities at the issuance of the CD will be compared to the price of these metals on 10 semi-annual pricing dates. The percentage change of each these prices will be averaged at the end of the five-year term, and, at maturity, the upside payment, if any, will be based on the equally weighted value of the averages of the performance of these four commodities. As with all MarketSafe CDs, should the overall performance be negative, clients will get their deposited principal back at CD maturity. This is 100% Principal Protection.5 The full details of this CD, including potential payout examples, can be found on the Product Term Sheet found here.
The current investment thesis for investing in the commodity complex is to take advantage of accelerating global growth that could drive higher demand in energy and raw materials. Global growth and excess liquidity should eventually drive higher global inflation levels, which may provide an optimal market for commodity exposure. That said, investments in individual commodities could likely remain a volatile investment strategy.
The diversification benefits to an investment portfolio’s risk-adjusted returns by adding non-correlated asset classes, such as commodities, have been well-documented in the Daily Pfennig® newsletter. In selecting gold, WTI oil, sugar, and copper for the MarketSafe Core Commodities CD, we have applied this concept of diversification into the construction of the product to provide investors with yet another layer of risk management in potentially reducing the volatility of the overall instrument.
With respect to the selection of these four commodities for this latest MarketSafe CD, it was important to identify investment opportunities in different subsectors of the commodity complex, having distinctive value drivers, in addition to the traditional global growth and inflation factors. In particular, this CD gives you exposure to the oil, industrial metals, precious metals, and agricultural commodities markets, combining a diverse range of macroeconomic drivers involving construction, consumption, transportation, consumer products, electronics, infrastructure investment, per capita income growth, and investment.
Commodity Index Values: Copper, WTI Oil, Sugar, Gold
01/2005 – 01/2017
Source: ICE Benchmark Administration Limited (IBA); International Monetary Fund; and U.S. Energy Information Administration, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org – Series: PCOPPUSDM, MCOILWTICO, PSUGAISAUSDM, GOLDPMGBD228NLBM. As of Feb. 15, 2017.6
While overall trading in these investments can be comparable based on the broader macroeconomic themes driving most commodities, the MarketSafe Core Commodities CD provides exposure to an index of commodities offering potentially more unique return profiles and diversification (Figure #2). As illustrated by the above chart, while the industrial commodities such as copper and WTI oil have tended to correlate relatively closely, the returns generated from precious metals and agriculture markets have tended to provide non-correlated diversified returns and, ultimately, help to enrich the overall portfolio’s risk-adjusted returns.7
Outlook For This MarketSafe’s Commodities
Of course, portfolio management and asset allocation ultimately lead to the critical decision of investment selection, and we think the MarketSafe Core Commodities CD offers a favorable blend of traditional and unique commodity investment ideas.
WTI Oil: As referenced in a recent Currency of the Month article, global crude oil prices have been recovering over the past year, as illustrated by WTI oil prices increasing about 65% from January 2016 to January 2017.8 This recovery has been bolstered by a nascent rebound in global economic growth, as well as an agreement by Organization of Petroleum Exporting Countries (OPEC) to limit oil production.9
While the November 2016 decision by OPEC and non-OPEC countries to reduce oil by 1.8 million barrels per day has ostensibly supported the rebound in oil prices to more than $50 per barrel,10 oil prices will likely remain stable in the $50 to $60 per barrel range as idled shale production in North America and Brazilian production returns on line to take advantage of higher prices.11 As one of the more volatile segments of the commodity market, investors should welcome any stabilization in the price of WTI oil.
Copper: As industrial commodities, both WTI oil and copper tend to be highly correlated to overall global economic growth, which, as previously cited, has shown signs of early recovery. Additionally, copper’s unique electric conductivity and high thermal properties have resulted in strong demand during increases in infrastructure investments, such as the modernization of U.S. manufacturing capabilities and infrastructure, and growth in the construction market.12
Sugar: Once known as “white gold” due to the scarcity of sugar cane, modern sugar production has become more stable and geographically diverse, operating cane and sugar beet manufacturing facilities across more than 120 countries. Sugar is utilized in a variety of food applications, most commonly as a sweetener, but also as a preservative, in baking products, canning and freezing goods, candy products, beverages, and in the fermentation process.13 Sugar is also used in non-food applications such as for slowing the setting of cements and glues, textile finishing and wound healing, and in the production of detergents and pharmaceuticals.14
Growth in the sugar market has historically been concurrent with rising global per capita income levels and an expanding middle class. Most recently, we have seen this driven by emerging market economic expansion in China, India, and Latin America. As income levels increase, diets tend to shift toward foods with a higher sucrose level such as soft drinks and processed foods, thereby increasing demands for sugar. Given ongoing demand shifts and the recently observed reduction in stock levels for sugar (Figure #3), we would expect sugar prices to continue to strengthen over the foreseeable future.
World Centrifugal Sugar: Ending Stocks
2012/2013 – 2016/2017
Source: U.S. Department of Agriculture
Gold: In addition to our view of gold as a good long-term investment, particularly at current price levels, gold has traditionally performed as an effective hedge against increasing levels of inflation. Given the extraordinary levels of global monetary stimulus injected into various markets, we think global inflation levels will likely increase over the next five years. Moreover, gold can be used in a manner similar to insurance to potentially help protect the portfolio against adverse global events.
We are excited to provide our clients access to this unique certificate of deposit, gaining exposure to a diversified portfolio of attractive commodities utilizing our proprietary MarketSafe investment structure. As I discussed earlier, some of these commodities have recently started to recover from multi-year lows, which could make this an opportune time to add exposure to these markets to your portfolio.
Open and fund your CD by March 23, 2017, to secure your spot in this innovative way to participate in the commodity markets with no risk to your principal deposit and unlimited upside potential. You can find more information and/or apply by clicking on the following link, MarketSafe® Core Commodities CD.
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Until my next opportunity to share my thoughts with you in another Daily Pfennig® edition…