Commodities: Ripe For The Picking?

Editor’s note: The following piece is an advertorial.

Commodities: Ripe For The Picking?
Most of you have probably heard the old adage, “The best cure for low prices is low prices.“ The saying typically holds true because of the law of supply and demand; as prices fall, supplies are cut and/or demand increases. Oftentimes, this is especially true when it comes to commodities. Sometimes these adjustments take time, and different commodities adjust at different rates depending on several factors, including their underlying cost structure. But, the rule tends to hold true over the long run and some of these factors are now pointing toward a possible reversal in the trend of commodity prices.

It’s All About Timing
Let’s begin with valuations. The prices of several commodities are currently at or near multi-year lows. This potentially gives investors the opportunity to buy low (borrowing from that other popular investing adage, “Buy low, sell high”). The commodity market, as measured by the popular CRB BLS Spot Commodity Index, peaked in early 2011 and has fallen just over 33% since.

Fig. #1
CRB BLS Spot Commodity Index Over The Past 5 Years

Source: Commodity Research Bureau BLS spot all commodities “CRB [CMDT] [Index]”, via Bloomberg LP, accessed [March/2016].

One of the main things that factored into this major correction was a slowing Chinese economy, which contributed to worries about a general global economic slowdown leading to pressure on the demand side of the supply/demand equation. At the same time, we have seen a sharp increase in the supply of one of the most important commodities – crude oil. The explosion of fracking/shale production in the U.S. combined with the recent lifting of sanctions on Iran and a refusal to limit production by members of OPEC has led to a global glut of oil.

On the agriculture side of commodities, we have seen warmer winters and wetter summers lead to bumper soybean and corn crops. In addition, Argentina recently eliminated its export restrictions on corn and wheat, which pushed futures prices on these two commodities lower as investors expect increased supplies to be available in the global market.1

The metals have faced headwinds on the other side of the supply/demand equation with expected demand for the industrial metals of copper and nickel falling in response to slower Chinese growth. At the same time, a changing interest rate environment has put additional pressure on the price of precious metals.

The Inverse Relation Between The Dollar & Commodities
In addition to the challenges presented by changes in supply and demand, the recent strength of the U.S. dollar has also had a major impact on commodities. As you can see from the graph below, since 1995, there has been a negative correlation between commodity prices and the U.S. dollar. Strength in the dollar has generally corresponded to a drop in the value of commodities, and when the dollar has weakened, the price of commodities has generally moved higher.

Fig. #2
CRB BLS Spot Commodity Index vs. The U.S. Dollar Index

Source: Commodity Research Bureau BLS spot all commodities “CRB [CMDT] [Index]”, via Bloomberg LP, accessed [March/2016].

As you can see from this chart, the dollar has been trading sideways recently after a sharp run in 2014-2015. At the same time, commodity prices – as measured by the CRB BLS Spot Commodity Index – have begun to rebound: moving nearly 3.5% since the end of last year when they hit a 6-year low. While some of the factors that have led to the dollar strength in the recent years are still in effect, many market watchers are now starting to believe that the latest round of dollar strength may be running out of steam. Former Federal Reserve Chairman Ben S. Bernanke, who was at the helm of the Fed throughout the last big drop in the U.S. dollar, thinks we may be in for a turnaround. In mid-January, the former Fed chief had this to say about the dollar: “Much of the appreciation in the dollar may have already happened – we may not see much more.”2

Don’t get me wrong; it isn’t as if central bank leaders haven’t “missed” calls before, but Bernanke is not alone in his prediction of a possible peak for the U.S. dollar as a couple of major Wall Street brokerage houses recently had to scale back their calls for continued dollar strength in 2016. The dollar’s path is closely tied to the expected path of U.S. interest rates and as readers of the Daily Pfennig® newsletter know, there are real questions regarding the ability of the Federal Open Market Committee (FOMC) to follow through on expectations of 4 interest rate increases in 2016.

The Case For Commodity Exposure
And the dollar isn’t the only trend that could be showing some signs of reversing. While there have obviously been a lot of factors weighing on the price of commodities over the past several years, recent signs point to the possibility that this downward trend could be coming to an end. The factors that could move commodity prices higher include central bank purchases of precious metals (China in particular), the emergence of a “middle class” in the emerging markets, a possible spike in inflation rates brought about by the massive amounts of liquidity pumped into the markets via Quantitative Easing (QE), and finally, an increase in geo-political tensions that could send investors back to these traditional safe haven assets.

I think the most important of these factors is the emergence of a “middle class” in India and China and the changes that this could trigger in the global economy. McKinsey Global Institute estimates that “by 2025, more than half of the world’s population will have joined the consuming classes, driving annual consumption in emerging markets to $30 trillion.”3 McKinsey goes on to say that the rise of the middle class in emerging markets will have an economic force that’s perhaps 1,000 times bigger than the Industrial Revolution in the 18th century. A “new Industrial Revolution“ in the emerging markets should lead to increased demand for all commodities.

But, regular readers of the Daily Pfennig® newsletter certainly shouldn’t need me to convince them of the many reasons why adding exposure to various asset classes is a good thing for most portfolios. The diversification benefits alone of adding the non-correlated asset class of commodities to a typical investment portfolio could make them an appropriate investment for many investors. And, getting this exposure with no risk to the invested principal4 is an added benefit of the MarketSafe® Commodities Solutions CD.5 This is our newest MarketSafe CD and has exposure to 8 different commodities, including 4 important metals, 3 agricultural commodities, and the “big daddy” of the commodity market: WTI crude oil.

Details Of Our Newest MarketSafe Offering
Like all of our MarketSafe CDs, this is an indexed, U.S. dollar-denominated deposit product. This CD, which offers 100% deposited principal protection4, is a limited time opportunity that brings you access to the upside potential of 8 commodities: WTI crude oil, gold, silver, soybeans, corn, sugar, copper and nickel with a maximum potential payout of 70% at maturity. It will have a 5-year term, and will use an annual average pricing model that some of our previous MarketSafe CDs have employed.

The initial price of the 8 commodities at the issuance of the CD will be compared to the price of these commodities on 5 annual pricing dates. The percentage change of each of these prices, subject to a 70% cap per commodity at each annual pricing date, will be averaged at the end of the 5-year term; and the potential upside payment upon CD maturity will be based on the equally weighted value of the averages of the performance of these 8 commodities. This CD does not pay a periodic rate of interest or annual percentage yield.

As with all MarketSafe CDs, should the overall performance be negative, you’ll get your principal back: this is 100% Principal Protection.4 All the disclosures, terms & conditions, including the CD’s term sheet, and anything pertinent to this CD can be found on our website, or we can send them to you if requested.

I am truly excited about being able to announce that this newest MarketSafe CD opportunity is now open for funding. From listening to some of the conversations on the desk over the past few days, I know this is something many of you have been waiting for, so don’t miss out!

As I discussed earlier, many of these commodities are currently sitting at or near multi-year lows, and we can’t predict just how long this window of opportunity will remain. Open and fund your MarketSafe® Commodities Solutions CD by April 14, 2016, to secure your spot in this innovative way to participate in the commodity markets with no risk to your principal deposit.4 You can find more information and/or apply by clicking here.

Until the next opportunity to share my thoughts with you in another Daily Pfennig® edition…

Chris Gaffney, CFA
EverBank World Markets, a division of EverBank